Sustainable Investing 

Over the past 20-years significant progress has been made in the provision of opportunities for investors to access strategies which recognise environmental, social and governance issues (ESG). More than ever people are looking to ensure that their investments more closely reflect their values on everything from good corporate citizenship, workforce and governance diversity, paying fair taxes to environmental practices and limits on carbon footprints. This has been driven by a number of factors with investor education, climate change, population growth and longevity all contributing to this focus. This type of investing goes by many names although it is often referred to as socially responsible (SRI), sustainable and ethical investing but underlying all these different titles, are processes designed to incorporate ESG factors into investment decisions, to better manage risk and generate sustainable, long-term returns.

As ethical, environmental and social issues become increasingly prominent in global dialogue, interest in sustainable investing is growing rapidly. Last year a report by the Global Sustainable Investment Alliance identified that globally in 2016 there were US$22.89 trillion of assets under professional management in the ESG realm. This represented a 25% lift since 2014 and equated to approximately 26% of all funds under professional management. In Australia the representation from funds that are being sustainably managed is even higher. The Responsible Investment Association of Australia highlighted in their 2017 Benchmark Report that as at 31 December 2016, responsible investment constituted $622 billion of assets under management which is almost half of all assets professionally managed in Australia. New Zealand has also seen substantial growth in this area with Kiwisaver playing an important role.

Underlying all these sustainably invested funds are a range of different implementation strategies. Historically the most common approach was to employ negative screens to exclude companies in certain industries or sectors for moral or ethical reasons. These “sin” stocks tended to include those generating their revenue from gambling, alcohol, tobacco and from the production and sale of armaments. Today though, ethical investing has evolved into “ESG integration” where asset managers look to better recognise and embed ESG factors across their processes. Within this approach, investors employ a range of methods including active ownership and engagement, positive screening for desirable company attributes and the adjustment of financial forecasts and valuation models for ESG factors. The ability for investors to execute on these strategies has improved dramatically over the past 5-years as company disclosures have evolved to account for a broad range of considerations including carbon emissions, board and executive diversity and compensation levels. Although the New Zealand Stock Exchange was slower than many other international markets to promote disclosure in this area, last year through the updated NZX Code and an additional Guidance Note, listed issuers are now required to report on ESG factors and practices as part of their non-financial reporting and if their respective Boards decide against such disclosure then reasoning must be given. This progression will drive our local corporates to increasingly consider environmental and social issues when determining their approach to business.

Historically one of the biggest hurdles to the adoption of ESG strategies by investors has been the concern around the potential sacrifice of financial returns relative to traditional investment options. The reality though is quite different and generally the weight of academic research suggests there is no performance penalty. As recently reported by the Responsible Investment Association of Australia, with reference to data provided by Morningstar, core responsible Australian large-cap share funds outperformed their benchmarks over 3, 5 and 10-year time frames while responsibly invested international share funds outperformed mainstream share funds over 3 and 10-year time horizons. This is consistent with work recently completed by Oxford University that identified that “80% of the reviewed studies demonstrated that prudent sustainability practices have a positive influence on investment performance”. The one historical caveat to this has been in strategies which were solely built around the exclusion of “sin” stocks such as tobacco and gambling, where the return outcomes have been more mixed.

Although ESG portfolios have occasionally experienced periods of performance headwinds, as we move into a world where governments and regulatory agencies are taking a more proactive approach to penalizing socially and environmentally unacceptable practices, the economic impost on many of these negatively targeted ESG sectors will become increasingly meaningful.

At Devon, ESG is a pillar of our investment framework and process and we actively engage with the boards and executives of the companies we own across our portfolios. For example, as the world embraces the challenge of climate change through the commitments made under the Paris Climate Accord and the recommendations from the Financial Stability Board’s Taskforce on Climate-related Financial Disclosure, Devon maintains an annual record of the emissions from the companies that we own and the carbon intensity of our portfolios are monitored on a quarterly basis. In preparation for New Zealand’s Nationally Determined Contribution to the Paris Agreement coming into effect in 2020, Devon has also started to engage with companies around the type of work they are doing to prepare for a strengthened emission trading scheme (ETS). As part of our ESG integration, scenario testing and cash flow modelling are also important parts of our investment process and as such we are already doing primary research and engaging with experts beyond company management to understand the environmental impact of our investments. A similar level of engagement and the consideration is also given to Social and Governance issues across the stocks that we own in your portfolios.