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Shareholder strikes on CBA, AGL and GMG shine spotlight on ESG investing

Glenn Freeman  |  25 Nov 2016Text size  Decrease  Increase  |  

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With three blue-chip ASX 200 companies rocked by shareholder strikes on executive pay within a three-month period this year, investors' cross-hairs are trained on environmental, social and governance (ESG) issues in Australian companies.

Goodman Group (ASX: GMG), AGL Energy (ASX: AGL) and Commonwealth Bank (ASX: CBA) were all targeted in the last quarter of 2016.

The Samarco dam disaster in Brazil last year--which left 19 dead and destroyed the livelihoods of many more--is another prominent example. The catastrophic breach of the tailings dam left the project's co-owner BHP Billiton (ASX: BHP) reeling, contributing to $4 billion in losses and an executive reshuffle.

"The entire board of BHP consumed a lot of their time and energy focusing on both how this happened, and how to prevent it from happening again," says Dan Smith, general manager at CGI Glass Lewis, a provider of independent governance services.

"You might think E&S [environmental and sustainability] issues don't occupy much time at the board level, but now you're starting to see ... these events occur on a reasonably frequent basis, and boards need to stay on top of it. And that has implications for investors exercising their ownership rights."

Smith spoke with Michael Jantzi, chief executive officer, Sustainalytics, who addressed a gathering of fund manager governance specialists in the Sydney offices of Morningstar last week.

Morningstar Sustainability Ratings were rolled out across the global Morningstar group in July 2016, using a methodology created in partnership with Sustainalytics, an ESG ratings specialist. Around 2,500 Australian funds now carry a Morningstar Sustainability Rating.

The ratings for funds and exchange-traded portfolios are normally distributed into five groups, represented by one to five globes. These are assigned after sorting funds in each Morningstar category by their respective Morningstar Portfolio Sustainability Scores.

The scores are an asset-weighted roll-up of company ESG scores from Sustainalytics research, with deductions taken for involvement in ESG-related controversies. Sustainalytics has ESG scores on 4,500 companies and controversy scores on 10,000 companies.

Morningstar normalises Sustainalytics’ company ESG scores to make them comparable across industry peer groups--a particularly important step when scoring diversified portfolios. A country-based guide, the Morningstar Sustainability Atlas, which tracks the level of ESG scores by fund across 35 Morningstar country indexes, was rolled out in October 2016.

"Wherever you go in the world, where ESG is gaining increased traction, people are engaged with it, because they simply believe it helps them make better decisions," Jantzi says.

He uses the analogy of an iceberg to explain how traditional research and analysis tools only provide insight into what is happening "above the waterline" in companies.

"But I think we can all recognise that the world is changed, and the risks that are now facing investment managers and portfolio managers are different than they were five, 10, 15, 20 years ago," Jantzi says.

"I argue we need a better equipped sonar, and that's what ESG analysis does. It doesn't replace traditional financial analysis, it just strengthens it and gives us a sense of what sits below the surface as well."

From a global perspective, Sustainalytics is having "some interesting conversations now with boards, especially in Europe with some pension funds ... they're actually starting to say 'ESG integration: of course we do that, it helps us make more informed decisions and fulfil our fiduciary duty'."

"But they're now actually starting to publicly question 'what good is a pension plan to our members, if they can't breathe the air, can't drink the water, if they're not living in a society with a strong healthcare system?' We're starting to see the expansion of ESG go from a security, to a portfolio, to a systemic level," Jantzi says.

This is taking root beyond an institutional level, with retail investors increasingly having consideration to issues around ESG in selecting companies for their investment portfolios--including the $200 billion self-managed super sector.

And not just in the selection of individual stocks.

"There is an assumption that ESG investing is all about equities, but actually now as part of the growth, there's been an expansion across asset classes and sectors: fixed income, real estate and infrastructure," says Jantzi.

Focusing on infrastructure, he says  ESG "makes a lot of sense, because these are projects that require significant capital outlay, capex, time horizon--when ESG can become a bigger risk".

"And quite frankly, Australia is way behind the curve on that front, which surprised me ... because it is such a robust, leading investment market here. But in 2013, there was nothing. We started to see some issuances in 2014-2015," Jantzi says.

"But we're seeing real signs of life in the green bond market here now ...  I expect we're going to see a lot more interest in that space."

He says he would be shocked if Australia didn't embrace that "because you're starting to see that around the world, with the catalyst being the Paris agreement".

"It's not just about looking at ESG from the risk perspective now, there's a lot of opportunity there, in embracing sustainability as an investment opportunity."

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Glenn Freeman is Morningstar's senior editor.

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