Roadmap for the ESG Maze

30 Mar 2021

By Dugald Higgins, Head of Real Assets & Listed Strategies and Chair of the Responsible Investment Committee

Our recent webinar ‘Responsible Investing: what does the Australian Sustainable Finance Initiative mean for you?’ explored a series of issues regarding the current environment in responsible investing. As part of this event, a number of questions were submitted by viewers which we believe are worthy of sharing. We’ve summarised these key queries and provided our views below.

What is the Australian Sustainable Finance Initiative (ASFI)?

The ASFI is a collaboration of major Australian financial services participants aiming to develop sustainable finance pathways, policies and frameworks to allow financial services to contribute more systematically to a more resilient and sustainable economy.

The ASFI is positioning itself to be pivotal in the development of Australia’s national sustainable finance strategy, having recently released the Australian Sustainable Finance Roadmap. The purpose of the Australian Sustainable Finance Roadmap is to facilitate a framework in which the financial system can support sustainability and resilience.

The roadmap contains several key recommendations including, but not limited to:

The ASFI has posed 37 recommendations in its roadmap, with the full details available at https://www.sustainablefinance.org.au/

ESG issues lack definition and investor values vary widely. How do advisers deal with this?

The non-homogeneous nature of ESG and the differences in beliefs, values and priorities of investors make ESG issues highly subjective and complex. We don’t currently believe advisers (or research houses) should dictate what ESG should mean to the investor. However, by understanding the different ESG strategies that exist, advisers can begin to analyse their implications for investor suitability and their impact on portfolios.

Generally, ESG strategies can be broken down into one of the following:

Generally, funds with a defined focus on ESG outcomes will use one or more of these to achieve their objectives. It’s important to note that each of these have a different outcome on returns, risks, costs and impact. Also, some strategies are more suited to certain aims. For example, exclusion-based strategies may be suitable for investors focused on avoiding certain sectors based on their values or beliefs. Impact strategies, however, are more suited to those with a specific focus on generating a positive environmental and/or social impact around defined goals.

Once a strategy is defined, a more targeted assessment can be made on its attractiveness, the manager’s implementation, and its effectiveness in achieving its defined goals. We believe that breaking down these nuances allows the adviser and client to make a more informed choice, facilitating the most optimal fit.

ESG has a positive impact on long-term returns, but the industry is generally short-term focused in assessing managers on performance. How should this be addressed?

It is a challenge. Investors can move capital with the click of a button whereas real world impact can take years to yield observable results. As with all funds, judgement purely based on performance is unhelpful without understanding what a fund is trying to achieve and how that achievement is measured.

Firstly, investors need to understand the ESG strategy being used and what that means for portfolio outcomes in both a financial and non-financial sense. Secondly, they also need to overlay the performance of the broader market and its drivers. And thirdly, investors need to think about time horizon, as some strategies, such as those with negative screens, may show more rapid attribution results than impact strategies.

Manager disclosure should also play a significant part. Transparency in investment management activities and outcomes is a key part of being able to support an ESG approach. This should aid understanding of a strategy and shift the focus away from a simplistic view on market-relative performance.

Should fund managers undertake their own ESG assessments and impact measurement?

We don’t believe that a lack of internal systems should be a barrier to operating a strategy. However, at a minimum, there should be appropriate frameworks, data, processing and auditing of results. There are many global standards and frameworks in place that managers can adopt across their asset classes to achieve this. However, such processes must be robust, transparent and verifiable.

How do advisers deal with inconsistent definitions and data?

Contradictory ESG data is one of the greatest challenges faced by the market. Multiple frameworks and standards, lack of common definitions for sustainable activities and inconsistent sustainability-related disclosure by companies (much of which is still voluntary), is a major impediment for many investors.

In an imperfect landscape, the first task is to understand what underpins the data. There are multiple key considerations to an ESG dataset: its reliability,  currency, comprehensiveness across a market and extensiveness in a historical context. Issues such as the source of data (is it self-reported? Is it verifiable?) and who is interpreting it are also critical. Once you understand the integrity of the data, you’re then free (or not) to embrace the view of the world that data provides.

Of course, this doesn’t solve the conundrum for advisers who are trying to grapple with these issues. Indeed, it’s the complexity of these challenges that have led us to introduce our own Responsible Investment Classifications across all rated funds. We see this as an important first step in focusing on how each fund approaches and incorporates ESG issues. We also believe that a consistent framework of identification across all rated funds will allow advisers to narrow their focus on what matters to them and their clients.

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