When Mint began our journey on including ESG (Environmental, Social and Governance) factors into our process many years ago, a common question was often “Why would you, surely you are just reducing your investible universe and hence lowering performance?” As with any change from tradition, some probing questions should be asked, are we giving up value for values?
Given the benefit of time and the increase in ESG driven funds, it is interesting to see the array of Sustainable/ESG funds on offer both locally and offshore, as well as how those funds have performed compared to their peers and the wider market. Looking through the recent Zenith Investment Partners month performance tables (largely Australasian funds), there certainly are groups of outperforming ESG/Sustainable funds that sit across different asset classes as well as sectors. While this is pleasing to see, hidden behind many of the other traditional funds will often be ESG factor overlays or integration that is also at play. The point here is that defining an ESG fund or strategy, and then comparing it to ones without, is becoming far harder and further, to then determine whether that is the driver of the outperformance becomes trickier again.
An interesting piece of work1 undertaken by Global AI Corp and Colombia Business School in 2020 investigated whether there was a relationship between ESG ratings and outperformance. They used ESG ratings for US listed equities from the reputable and commonly used 3rd party provider MSCI to see if they could back test the ratings and see whether this generated outperformance over a set period. While it is by no means perfect, and I am simplifying a little here, the research looked at ESG momentum (rating changes) of companies within the MSCI US index over a 6 year period and used this to put together a portfolio of the top 10% rated companies and compared this to the benchmark itself. The result was a portfolio that generated outperformance of 5.6% per year over the benchmark, a very good outcome!
Closer to home the Macquarie research team in Australia undertook some similar work2 using the major Australian equity index (ASX200). They broke down the stocks under coverage into three baskets of best, middle and worst by ESG scores and have been following the performance of each basket of companies over the last ten years. The top basket of companies with the “best” ESG ratings outperformed the bottom basket by 6.0% on an annualized basis and beat the ASX200 index. Interestingly, not only did the top basket outperform the rest, it did so with lower volatility, hence superior risk adjusted returns (better information ratio) – the holy grail for fund managers!
While these are only a few of many examples, it is clear that ESG assessments and integrating this into the investment process is anything but a hindrance. In fact, it provides a more complete understanding of investments being made with likely better outcomes for investors for performance, risk and those non-financial ESG factors. So, what does responsible investing mean?
The evolution of Responsible investing has come a long way and even more so in the last 5 years. Early on, many investors focused on the names or sectors that did not align with client’s views or expectations in an investment portfolio. This method is called negative screening or, put simply, a list of industries that are excluded from a fund’s portfolio. While this method avoided the ‘sin stocks’ and was very easy to implement, it could lead to outcomes where the manager might start by ruling out the excluded stocks, and then resort back to their standard investment process without any further consideration to companies’ sustainable credentials.
Thankfully, most investors have moved on from this simple once over exclusion process and we now see many different ways of including ESG into the investment process. Outside of exclusionary screening, other common methods now used include Best-in-class, Impact investing, Thematic investing and Stewardship to name a few.
ESG integration is another more commonly used method and one we undertake at Mint. This involves the explicit inclusion of ESG factors into the investment process for consideration when selecting investments in our portfolio. These considerations are key to making a fully informed decision in any investment process and when investing over a long time horizon we believe that companies that are better at managing such risks should be able to have better and more sustainable outcomes.
Each investment analyst at Mint is responsible for a full ESG assessment for every investment we make or consider. This involves assessing all available details released by companies but also through active engagement and continual conversations with each company under consideration. Our assessment works through the three segments of ESG by applying our own proprietary score card, which we then use for assessing companies on their policies, practices and outcomes.
As you can see, there are many ways to include ESG factors into portfolios beyond the simple exclusions. We expect that this will continue to evolve, especially as more data and disclosure from the investment universe becomes available. At Mint, we continue to update and enhance our ESG processes and review these annually. Making sure we have the right data, are asking the right questions and getting the right outcomes for our clients.
Responsible investing has come a long way, from a niche area of focus to a mainstream way of investing, in what appears to be a relatively short time. It is clear that ESG, Responsible/Sustainable investing or whatever you want to call it, is here to stay.
While we do not expect all investors and managers to have responsible investing at the forefront of their focus, the minority has certainly become the majority when it comes to the demand for funds undertaking some form of a sustainable strategy in their investment process.
The numbers certainly support this view too, as seen in the recently released Responsible Investment Benchmark Report Aotearoa New Zealand 2021 by RIAA (Responsible Investment Association Australasia). Some of the key data points to note were that there are now $142bn (as of 2021) of assets under management with a Responsible investing strategy. This number grew at 28%, over twice the speed of the general market at 11%. It is likely that while most will be people voting with their feet and seeing money move/grow with RI managers, some managers themselves will be moving to become RI managers.
Offshore we are seeing similar trends, with the growth in signatories to the PRI (Principles for Responsible Investment). PRI is an independent organization and leading proponent of Responsible investment; helping to understand and incorporate ESG factors into investment and ownership decisions for its signatories. When PRI was launched back in 2005 (by the late Kofi Annan, then the United Nations Secretary-General), it was supported by leading institutions from 16 country’s (~60 signatories) with over $6 trillion USD of assets under management. Roll forward to 2021, and this has grown to 3800 signatories with $121.3 trillion USD under management (+24% for 2021 alone), certainly no small feat!
Another key factor of why this is not a fleeting fad, is how seriously corporates are (or beginning to at least for some) considering these factors. We have seen steady improvements by corporates with integrated reporting / ESG disclosures and now, we are seeing regulatory requirements coming into play here in NZ. The NZ government is mandating climate related disclosures in line with the TCFD (Task Force on Climate–Related Financial Disclosures) for listed issuers (debt/equity listed >60m), banks, insurers, managers of registered investment schemes from 2023, so I do not see that unwinding anytime soon!
Like it or love it, Responsible investment, and its many iterations are, here to stay and that has to be a good thing for everyone.
Mint reports and is assessed annually by the UNPRI on its ESG (environment, social and governance) investment process framework and controls. Our current A+ rated assessment is available on our website.
Disclaimer: David Fyfe is a Portfolio Manager in the Investment Team at Mint Asset Management Limited. The above article is intended to provide information and does not purport to give investment advice.
Mint Asset Management is the issuer of the Mint Asset Management Funds. Download a copy of the product disclosure statement.
1 Antoncic, Madelyn and Bekaert, Geert and Rothenberg, Richard V and Noguer, Miquel, Sustainable Investment - Exploring the Linkage between Alpha, ESG, and SDG's (August 2020). Available at SSRN: https://ssrn.com/abstract=3623459 or http://dx.doi.org/10.2139/ssrn.3623459
2 Stanley, Anita and Stubbs, Sue Lyn and Chua, Vivian (Macquarie Securities (Australia) Limited). Australian ESG Equity Strategy, Macquarie’s 2021 ESG Ratings Report (December 2021)
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