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THE concept of responsible investing has evolved hugely over the past decade, and the pace of change is accelerating.
Not necessarily in clear directions, however.
We’ve reached a point where there wouldn’t be many boards or management of major Australian listed companies not taking Environmental, Social and Governance (ESG) risks seriously.
A cursory glance at MSCI ESG ratings shows an improvement in scores across the market in recent years.
As one of the leading sustainable investors in the country, Pendal has played an important role in this transition, driving companies to change.
This is something we are very proud of.
It’s also reasonable to believe that the potential alpha available from targeting “box-ticking sustainability improvers” has eroded over time.
Curiously, companies that are deprived of capital as a result of poor ESG behaviours may well have higher expected returns, at least over shorter time periods.
This reflects their higher risk and lower multiples. Certainly, higher fossil fuel prices over the past year made excess returns very challenging for sustainable investors.
Nevertheless, we know that changing consumer preferences, increasing transparency and a significant shift in the direction of policy settings are real.
These will demand ever more vigilance on behalf of corporates to stay on top of their sustainability agenda.
So, what does this new ESG environment look like?
Firstly, box ticking will become increasingly less helpful.
The challenge for investors is identifying authentic leadership that can leverage non-financial factors to generate real economic value.
Since many of the basic hygiene factors are already considered, it will become particularly difficult for systematic processes like those used by the mainstream ESG score providers to assess this.
It is here that Pendal’s deep fundamental research resources will be well placed.
Secondly, the next horizon is one of impact.
What are the externalities created by a company? To what extent is a company, through its product and services, making the world a better or worse place?
Many see this as the third axis of investing.
The first was return, the second was risk — and the third is impact.
Notoriously difficult to measure, full of unintended consequences and spurious correlations, impact is nevertheless a real component of allocating capital.
It is the “so what” of owning a business and holding management accountable.
In 2023, the Federal treasurer has started asking sincere questions of the role of financial markets in impacting our society as whole.
The influence that we have on our system as stewards of capital has never been lost on us.
This report aims to highlight how we have carried out this responsibility.