ESG makes business sense in tackling tomorrow's problems today

ESG makes business sense in tackling tomorrow's problems today

This article first appeared in the AFR on the 17th August 2021
Written by Alexandra Cain

Addressing climate change is an enormous investment opportunity that could create many winners among governments, businesses and individuals.

First there was the triple bottom line. Then there was sustainability reporting.

But the term that’s now preferred is ESG – which stands for environmental, social and governance. They all refer to a very similar dynamic.

It’s no longer appropriate for investible businesses to simply report their financial information.

Now, retail and institutional investors expect businesses to report on how they affect the world around them, the communities they touch and how they are run. The climate-change crisis means there’s now a sense of urgency around this.

Kate Howitt is a portfolio manager with investment house Fidelity International, which operates in more than 25 countries with $US739.9 billion ($1 trillion) in total assets. She believes investors have a critical role to play in addressing climate change.

“Previously, the way our communities worked is if there was an environmental issue we would elect representatives to government and they would make laws and set regulations, and standards would be enforced on companies that way,” she says.

“Unfortunately, climate change is harder, partly due to increasing political polarisation in most Western countries that makes it harder to pass laws. The other thing that makes it hard is we’re talking about the atmosphere. Which requires a global approach.

“We could regulate Australian companies, but it won’t make much difference to addressing climate change if other countries are polluting the atmosphere with carbon.

“Because of the urgency of this issue, another approach is to get investors to pressure companies. Sometimes this is characterised as unelected investors trying to usurp national sovereignty. But this is such a difficult crisis, we’ve got to try everything we can.”

Howitt notes investors are not trying to be legislators. “Investors talk about all kinds of risk, but planetary risk is one you don’t hear about much. If you look out to 2040, well within the investment horizon for accumulation-stage investors, our baseline model is high single-digit returns, say 6 per cent to 8 per cent, for emerging market assets.

“These are very attractive returns; the highest of any asset class. Every Australian investor would be exposed to these markets through their superannuation fund.

“But returns from emerging markets drop to zero or negative once you factor in not addressing climate change because these markets will bear the brunt of disruption from accelerated climate change events.

“Then, factor in the manufacturing role these markets play for the global economy and the flow-on effect this will have to other markets and other assets. Investors have a fiduciary duty to think about how to address these issues because we have to safeguard investor returns.”

The pandemic and, before that, the deadly bushfire summer of 2019/2020 have sharpened investor focus on the potential for ESG issues to constrain investor returns.

“People are much more aware about climate risk and health fragility and the need to do something about it than they were in the past,” Howitt says.

“We weren’t prepared for a pandemic and we need to be better prepared for climate change. So ESG is becoming more important now because there’s been a massive shift in community awareness of the need to do something and the willingness to try to get change happening now.”

Ownership Matters’ co-founder Dean Paatsch says ESG has become more prominent because people want their investment to generate financial returns without them having to experience cognitive dissonance because the assets producing those returns are out of step with their personal values.

“They have seen too many examples of environmental mismanagement, indifference to social issues and disregard of governance norms impacting on financial returns,” he says. “None of us wants to think our retirement is being funded by tobacco companies.”

When it comes to returns, the Responsible Investment Association Australasia’s long-term data clearly shows investment managers that take ESG factors into account outperform the market over time.

RIAA’s executive for policy and standards Nicolette Boele notes environmental, social and governance factors are well and truly part of how investment managers look at risk.

“When you have big shocks like the fires we’re seeing in Europe at the moment, these things become very real,” she says. “If an investment manager is really looking at environmental, social and governance factors in how their investee companies are managing shocks they are better than funds that don’t consider these factors.

“The overwhelming majority of Australians expect their retirement savings are invested responsibly and ethically. Our research shows funds that account for ESG factors on average outperform Australian and international multi-sector investment funds over one, three, five and 10 years.”

There’s a colossal volume of money that takes ESG into account. There are now 450 global institutional investors that have signed up to the UN’s Principles for Responsible Investment, representing more than $US40 trillion in assets under management. The UN PRI is an independent body. It encourages investors to invest responsibly and with reference to ESG factors to enhance returns and better manage risks.

“Shareholders will sell the shares of companies that do not take ESG seriously, put in place appropriate targets and strategies to meet those targets,” says Howitt. “That pushes their share price lower and their cost of capital higher.

“So, the longer a company takes to address ESG, the more expensive it’s going to be to do something about it. Your share price goes up if you are perceived to be a good corporate citizen. That means your cost of capital goes down and the financing you need to de-carbonise is less expensive to your shareholders.”

Howitt references estimates for the cost of the world to de-carbonise of between $US100 trillion and $US150 trillion. That equates to $US4.5 trillion of investment required every year. To put that into context, US GDP is $US21 trillion a year. Australian GDP is $US1.4 trillion ($2 trillion) a year.

Says Howitt: “That’s a lot of money and it really matters how quickly and efficiently it’s invested. We need to get going. The good news is addressing climate change is an enormous investment opportunity and there is the potential for serious winners. This is ultimately a huge gold rush, and there will be fortunes made.”

 

 

 

“We weren’t prepared for a pandemic and we need to be better prepared for climate change. So ESG is becoming more important now because there’s been a massive shift in community awareness of the need to do something and the willingness to try to get change happening now.”

 

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Prior to making an investment decision, retail investors should seek advice from their financial adviser. This document is intended as general information only. Please remember past performance is not a guide to the future. Investors should also obtain and consider the Product Disclosure Statements ("PDS") for the fund(s) mentioned in this document before making any decision about whether to acquire the product. The PDS is available on www.fidelity.com.au or can be obtained by contacting Fidelity Australia on 1800 119 270. The relevant Target Market Determination (TMD) is available via www.fidelity.com.au. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider such matters before acting on the information contained in this document. This document may include general commentary on market activity, industry or sector trends or other broad-based economic or political conditions which should not be construed as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be construed as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity's funds is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. References to ($) are in Australian dollars unless stated otherwise. Details of Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website.

© 2021 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.

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