Environmental, social and governance (ESG) concerns are a rising trend in investment decision-making globally.
Between 2016 and 2018, the value of sustainable and responsible investment assets in Europe, the US, Japan, Canada and Australia/New Zealand rose by 34 per cent to $30.7 trillion.
This trend has been accelerating the fastest in the United States. More than one-third of global sustainable investment assets are managed in the US.
Research from Monash University also found that investors were particularly sensitive to ESG controversies.
Dr Bei Cui from the Monash Centre for Financial Studies examined the share prices of US S&P1500 companies before and after ESG events and found significant market overreactions to ESG controversies.
“[W]hen an ESG controversy occurs, investors give too much weight to the possibility that the event will be repeated and therefore overreact to the news. Consistent with this proposition, my study found a negative effect on returns when negative ESG news was released, but that these returns mean reverted over the subsequent 90 days.”
These patterns of market overreaction were similar across most of the 23 countries surveyed.
The study included Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States.
ESG news events included labour issues, war, security, pollution, civil unrest, industrial accidents, corporate responsibility, crime and health.
What is happening in Australia?
Similar trends have also been highlighted in Australia.
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The Responsible Investment Benchmark Report 2020 (the Report) was released early this week. The Report was researched in collaboration with KPMG and found that companies who have good employment policies, minimise their environmental impact, have good governance and protect human rights across supply chains deliver superior financial returns.
The Report revealed that Australia’s responsible investment market was valued at $1,149 billion in assets under management in 2019, rising from 17 per cent in 2018. Responsible investment is now 37 per cent of Australia’s total $3,155 billion market in professionally managed assets.
Multi-sector responsible investment funds also outperformed mainstream funds in 1, 3, 5 and 10 year time horizons during 2019.
Julia Bilyanska, Director in Sustainability and Risk Assurance at KPMG, explained how ESG is directly tied to performance and growth.
“There is growing evidence that managing ESG (both risks and opportunities) contributes to sustainable and successful performance. This has been tested through the current COVID 19 pandemic in particular.
“Our work with RIAA has found that Australian and multi-sector responsible investment funds have outperformed mainstream funds over every time horizon. There is also an increasing body of research demonstrating that more sustainable companies are performing better than the general market.”
Mr Yo Takatsuki, Head of ESG Research and Active Ownership at AXA IM, explained how the rise of responsible investment and lessons from the pandemic have prompted AXA IM to re-prioritise social responsibility.
“This year’s report highlights the significant growth in responsible investment and shows investors do not need to compromise on performance to invest responsibly.
“The COVID-19 crisis has highlighted the increasing importance of active ownership and provided an opportunity to redouble our efforts as responsible investors to drive change. In the first half of 2020, AXA IM increased its engagement activities around human health, public capital, and shareholder rights, and engaged more than 180 issuers at around 4,300 shareholder meetings globally.”
Mark Spicer, Head of ESG/Responsible Investing at KPMG Australia, also added that demands for transparency are increasing.
“There are some really great signs of a growing maturity in the RI market in Australia, however more can be done by the majority of asset managers to demonstrate how RI strategies are embedded into their investment approach and to report on the associated impact of their approach. Members want it and investment mandates are increasingly demanding greater transparency.”
What are businesses doing in response to this investment trend?
The Report found that 86 per cent of investment managers had a responsible investment policy and 70 per cent had made them publicly available.
ESG integration is now considered “business as usual” by survey respondents. 87 per cent of responsible investment AUM (a total of $1 trillion) are managed using ESG integration as a primary approach.
“Consideration of environmental, social, governance (ESG) factors is now the expected minimum standard of good investment practice, with $1 trillion of Australia’s AUM managed using ESG integration as a primary approach. This approach is closely followed by corporate engagement and shareholder action,” said Simon O’Connor, RIAA CEO.
These trends have only been foregrounded by the current pandemic.
The closure of factories, transport curtailments and lockdowns have dropped Australia’s carbon-dioxide levels by 10 million tonnes in April to June. Globally, emissions dropped around 4 per cent.
“The COVID-19 pandemic has resulted in significant economic turmoil, severely impacting many people’s livelihoods and financial markets globally. However it’s become clear that responsible investors are ahead of the game. They are identifying the key themes influencing markets and returns, which helps them to better navigate turbulent times, avoid the biggest risks and capture more opportunities,” said Mr O’Connor.
“Companies or assets are unlikely to thrive if they ignore issues such as climate change, health and safety, labour rights, corruption, and lack of diversity. Investors are fast realising that consideration of these issues provides more informed investment decisions, such as valuation and asset allocation.”
AXA IM expressed how they will preserve environmental benefits as the economy fires up again and lockdowns are eased.
“A pure divestment, decarbonisation approach can pose unintended problems for investors. These problems may arise in the form of increased active risk, reduced diversification, and can also mean investors have less leverage to use when engaging with companies. We also believe a blanket approach to divestment means companies who are evolving may not have access to enough capital to facilitate positive change,” said Mr Takatsuki.
However each company’s ESG strategy will differ.
“ESG risks and opportunities vary across companies depending on the nature of operations and impacts (both positive and negative) that the operations have on the environment and society,” said Ms Bilyanska.
“Identifying those risks and opportunities and prioritising significance of their impacts is increasingly important for businesses as investors, regulators, activists and society more broadly expect transparency around non-financial impacts and performance. Various international frameworks are available to help guide the identification and prioritisation of ESG impacts. Global Reporting Initiative Standards, Sustainability Accounting Standards Board, Taskforce on Climate-related Financial Disclosures and International Integrated Reporting <IR> Frameworks are to name a few of the more prevalent ones.”