By Ben Falkenmire
Illustrations Neil Webb

Instead of a bump in the road, the COVID-19 pandemic appears to have been a tipping point for responsible investing. A widespread mood to ‘build back better’ is seeing green bonds and social bonds, which raise money to go to positive environmental and social projects, soar in popularity.

In the first half of 2021, almost US$300 billion was raised globally in the sale of green bonds, almost surpassing the record US$309 billion sold during the 2020 calendar year. Investments in sustainable assets were up 96% in 2020 from 2019, noted BlackRock CEO and chairman Larry Fink, and it could be even higher in 2021.

Many wise heads – including Richard Brandweiner, an alumnus of the Cranlana Centre for Ethical Leadership, chair of Impact Investing Australia and chief executive, Australia, of investment manager Pendal – consider this to be the beginning of a long-term transition in asset allocation.

“2020 was a landmark year,” he says. “We had the bushfires with blood red skies and ash on our coasts. We had the #metoo and Black Lives Matter movements, and then the pandemic. It was an incredibly significant year in recognising that we have an obligation to each other and to operate in a way that’s mindful of our collective future.

“It was an incredibly significant year in recognising that we have an obligation to each other and to operate in a way that’s mindful of our collective future.”

“The management and board changes as a result of Juukan Gorge [at Rio Tinto] and at AMP wouldn’t have happened 10 or 15 years ago,” Brandweiner continues. “Society is increasingly holding people to account for behaviour that goes beyond a linear definition of maximising shareholder return. People are recognising it’s actually about optimising outcomes for all stakeholders, because if you don’t, you won’t have a good business.”

Viable returns

Evidence suggests investors are not having to sacrifice returns, either. An analysis of more than 2000 studies on ethical investing over the past four decades, published in 2015, found sustainable investing produced returns as effectively as other investment approaches.

Harvard Business School professor George Serafeim has also published research showing superior returns are possible if you keep things simple, says Pendal’s head of responsible investments, Edwina Matthew.

“They found if you try and cover all the ESG [environment, social and governance] factors in investing, it can detract from performance. It’s the managers that move away from the noise and focus on the material issues that get the value,” she says.

It is no wonder many investors have shifted their thinking on responsible investing from ‘why?’ to ‘why not?’

Younger generations lead the charge

Responsible investing is not a 21st-century child. Ethical considerations have long been part of the investment equation for Muslims, Quakers, Methodists and others. Socially responsible mutual fund Pax World, launched in 1971, was set up by two Methodist ministers who wanted to avoid putting church funds with companies contributing to the Vietnam War.

The world’s first socially responsible investing (SRI) index, the MSCI KLD 400 Social Index, was formed by investment research firm MSCI in 1990. In 2006, the UN published its Principles for Responsible Investment.

ESG data gave credence to risk management before people realised ESG could drive earnings, not just affect them, and the broader concept of sustainable or responsible investing was born.

CA ANZ’s 2021 Investor Confidence Survey, released in August, found just over half the 1500 Australian and New Zealand investors surveyed believe companies should behave in an ethically, socially, environmentally and responsible way. But that sentiment was much stronger among younger investors – it climbed to 73% among people aged 18 to 54 and dipped to a low of 39% for people aged 55 and older.

David Armstrong FCA, CA Financial Planning specialist, a financial adviser and director at Modoras Financial Performance Solutions in Sydney, says most of his baby-boomer clients in the past have placed returns before sustainability, in contrast to his millennial clients who have sustainability much higher up the interest scale. But the mood is also shifting in the older age group.

“Clients are involving their children in financial discussions and they are tweaking to where the kids want to invest more,” he says. “A lot of these younger family members have higher education and stronger opinions on things boomers might not have thought about.

“The problem is there is not as much reliable ESG information as there should be.”

“The problem is there is not as much reliable ESG information as there should be. It should be clear what the benefits of an ESG investment are because often you find that when you dig deeper, what you first thought was a great ESG idea isn’t one.”

“Often you find that when you dig deeper, what you first thought was a great ESG idea isn’t one.”

The problem of greenwashing

The dizzying number of ESG categories, a lack of reporting standards, and ‘greenwashing’ (faking or overstating a company’s environmental soundness) have made some investors reticent about jumping on the sustainability train.

Late last year, a survey for asset manager Schroders found 60% of institutional investors were concerned that greenwashing – “a lack of clear, agreed sustainable investment definitions” – threatened their sustainable investment intentions. Almost half (48%) cited a lack of transparency and reported data as restricting their ability to invest sustainably.

To sort the genuine ESG funds from the pretenders in Europe, the EU brought in Sustainable Finance Disclosure Regulation (SFDR) in March. Deutsche Bank-controlled fund manager DWS has already felt the pinch, with second-quarter reports showing only €87 billion (19%) of the €459 billion of investments it labelled ‘ESG’ qualified under SFDR regulations.

What is an ESG or sustainable investment is still open to interpretation, and some companies and funds are attempting to exploit the lack of consensus. In July, New Zealand’s Firstgas was ordered to remove ads claiming its gas was going carbon zero, the implication being customers could use gas with environmental impunity.

Investors and shareholders are holding managers accountable, but there is only so much they can do.

So, how do advisers navigate these tricky waters to ensure investors are getting what they value?

Connecting client values with investments

Angela Manning CA, CA Financial Planning specialist, executive director of Private Wealth Management at JBWere in Melbourne, says JBWere starts by finding out what is important to the client.

“We query clients to find out what matters to them,” she says. “We use thematics such as those in the UN Sustainable Development Goals (SDGs) to see if there is a particular interest where a client wants to make a positive impact.”

JBWere also gives every fund, regardless of asset class, a responsible investment (RI) rating of positive, neutral or negative.

“The rating is based on our own research, reports from global tier-one banks, and ESG ratings by MSCI and Sustainalytics,” Manning explains. “We also look at their ESG and RI policies, how they’re getting involved in advocacy, diversity characteristics of their investment team, and how their strategy aligns with the SDGs. We get quite granular.”

Armstrong says Modoras also performs in-house research to select ESG investment options. He finds funds a more attractive option than companies because funds enable clients to spread risk across the ESG universe.

Karen McWilliams FCA, business reform leader at CA ANZ, adds that CA ANZ is incorporating sustainability topics into the CA Program, its conference programs and continuing professional development (CPD) offerings.

She recommends identifying one or more SDGs to make a positive impact on.

“The key is not to have a negative impact on an SDG area. If you’re having a positive impact on one area but a negative impact on another, then you’re missing the objective,” she points out.

Picture: Karen McWilliams FCA.

Regulation is coming

In response to investor demand for more transparency and data, regulators are sharpening their pencils. Europe is leading the way in the funds space with its recently enacted SFDR. The EU also has a taxonomy (classification system) for environmentally sustainable activities that many consider a game-changer. And its recent Corporate Sustainability Reporting Directive (CSRD) sets greater auditing and reporting requirements.

US regulators are catching up with speed. US Securities and Exchange Commission (SEC) chair Gary Gensler is calling for the agency to develop a climate-disclosure rule by the end of the year and is considering making funds disclose the criteria and data behind their ESG claims.

Another one to watch is the IFRS Foundation’s project to create an International Sustainability Standards Board that will set sustainability standards. It put out a call for a chair and vice-chair of the proposed new board in June.

Corporates are taking action, recognising the long-term value in mitigating climate change risk. BlackRock’s Fink called for companies to integrate a net zero emissions business plan into long-term strategies in his 2021 letter to CEOs. Even resources giants Origin Energy, BHP and Whitehaven Coal are mulling over responses to shareholder calls for a climate response. 

“There’s a whole alliance of pension funds around the world saying we need to be net zero by 2050, but they’re not entirely sure how to get there,” says Brandweiner.

“There’s a whole alliance of pension funds around the world saying we need to be net zero by 2050, but they’re not entirely sure how to get there.”

“We’d like to see a harmonisation of standards around the world, and improved disclosures from companies around non-financial factors. We’d also like to see more investors recognise they have power, through their investments, to change the world.”

Read more:

From CA Library

Capitalism at Risk by Joseph Bower is a call to action for business to be both an innovator and activist.

Harvard Business Review article

“Overselling sustainability reporting: we’re confusing output with impact” by Kenneth Pucker suggests how sustainability reporting can work to drive down environmental threats.