Bringing ESG considerations into the investment process

Contrary to popular opinion, environmental, social and governance (ESG) considerations are not niche investment philosophies.

Contrary to popular opinion, environmental, social and governance (ESG) considerations are not niche investment philosophies for a select group of environmentally sensitive investors. Rather, they are an integral part of the investment process for many investment managers.

A consideration of ESG issues is an increasingly important part of the investment process and can be a contributor to the success of investment managers.

ESG considerations provide investment managers with another dimension to their investment process, alongside more traditional measures such as financial and management screens.

ESG research can provide insight into the long-term prospects of companies, which allows mispricing opportunities to be identified and exploited to maximise returns to investors. As the full implication of ESG issues becomes evident, it is important that mainstream investment managers demonstrate leadership in this area.

A hurdle to achieving the full integration of ESG considerations into the investment process is external broker research produced for investment managers, which often fails to adequately combine traditional financial measures with ESG considerations.

This can make it difficult to readily consider the materiality of ESG issues to the long-term outlook and sustainability of companies.

In response to this, two leading industry super funds, HESTA and VicSuper, led the development of a new initiative called ESG Research Australia.

This initiative was created to encourage external research that includes ESG considerations, and is a great example of how collaboration between investment managers and their clients can lead to a positive outcome.

Similarly, the Investment and Financial Services Association (IFSA) successfully collaborated with its members to produce the IFSA Blue Book, which outlines the corporate governance practices that investment managers would like to see adopted by listed companies.

It is important that these governance recommendations are adopted to help ensure that listed companies act in the best interests of their investors and remain sustainable for the long term.

The mainstream research market needs to receive consistent signals from investment managers and superannuation fund clients to deliver the research that investment managers need. Through collaboration, a clear signal can be sent to the sell-side community that the investment industry expects rigorous research of ESG-related issues.

The United Nations Principles for Responsible Investment (UN PRI) commits signatories to work together to enhance their effectiveness in implementing the principles.

Closer collaboration between asset owner clients, with each other and with the broker community to facilitate the development of quality ESG research will help signatories fulfil their commitments.

The challenge with getting companies to report on ESG issues is the perception that the investment management community is ‘short term’ in focus and only concerned with short-term earnings reporting, rather than longer-term ESG issues.

Consequently, the information that companies provide is not written in a style consistent with what investment management companies need to integrate the information into their investment processes.

As brokers are increasingly asked for ESG research, they, in turn, will start requesting information from companies on their ESG performance.

Once there is a critical mass of the investment community requesting ESG performance information from listed companies, everyone will have better information to work with.

As the focus on ESG issues gathers momentum in the broader investment management industry, there needs to be careful consideration of all steps in the investment process to enable us to best integrate and manage these issues.

Active ownership and a focus on proxy voting are two examples where major shareholders have the opportunity to influence and encourage best practice management of ESG issues in the companies in which they invest.

Investment managers should take this responsibility seriously and seek to vote on all proxy resolutions where possible.

They can also directly engage with companies in which they invest, on a variety of ESG issues. This active engagement is an important part of being a fiduciary.

The investment management industry needs to think more broadly about the long-term impacts of ESG issues and their effect on the sustainability of companies.

There needs to be increased dialogue and co-operation pertaining to government policy and industry regulations as they relate to ESG issues.

The successful integration of ESG considerations into the investment process will take time. However, acceptance that they have the potential to affect companies’ prospects and long-term sustainability will increase the focus on this area.

This will lead ESG issues to be considered equally with more traditional measures that, in time, will make them an integral part of the mainstream investment process.

David Dixon is chief investment officer at Colonial First State Global Asset Management .