Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 248

Investors expect ESG issues to drive returns

Once seen as a niche market segment for socially-conscious investors, Environmental, Social and Governance (ESG) investment research has gone global, including here in Australia. In the financial sector, many institutional players realise issues such as climate change, human rights, and workplace diversity can drive risks and returns. They recognise the need to be more knowledgeable on the matter and are looking for ways to integrate ESG factors into their investment process.

ESG benefits for investors with longer investment horizons

Investors have become more aware of the wider implications that ESG issues can have on a company. For example, a recent explosion in the US state of Colorado caused the shares of an oil and gas exploration company to drop significantly. This was not due to the damage to equipment or problems with production, but because investors feared the fallout from protests and mounting pressures to increase regulation. A decade ago, the market likely would not have reacted so swiftly or aggressively.

Investor focus on ESG is growing in all regions of the world, from the Nordics and the Netherlands where ESG has been on investors’ radars for decades, to the US, Canada and Australia. In Asia, China is focused on improving air and water quality and Japan is busy implementing the new stewardship code put forth by Prime Minister Abe's government. Closer to home, the local Financial Services Council (FSC) launched Australia's first compulsory asset stewardship code in July 2017. Compliance with this code will be mandatory for all asset manager members.

One of our recent investments in China shows how an investor can take an integrated approach to ESG research. For an investment in a Chinese beverage manufacturer, we found that 80% of the company’s facilities were located in areas of high water stress and scarcity, according to data from the Chinese Statistical Yearbook and Aqueduct’s water risk map. We queried the firm’s investor relations director, whose response supported the case to include water scarcity in our valuation model. Our analyst placed the highest valuation discount on this firm, which resulted in a 20% lower share price target.

This example demonstrates investors must take a step back and re-evaluate the stocks they own or are planning to buy. Investors can no longer just review standard financial measures such as profits, sales and the order pipeline. They also need to look at factors such as safety policies, accident rates, and carbon reduction targets. Are the policies helping the company avoid controversies? Moreover, what are the risks if something goes wrong?

Consider local and global issues

Local issues are also important. Does the company operate in a country rife with corruption risk? How are the locals reacting to a given project? Investors taking a broader viewpoint can potentially reduce their investment risks, spot new opportunities, and allow ESG to add value, especially over the longer term.

A clear example of the rise of ESG is found in the number of financial parties who have become signatories to the Principles for Responsible Investment (PRI), the world's leading proponent of responsible investing. Currently, there are 1714 signatories with a total of $68.4 trillion under management. The PRI helps investors to incorporate ESG factors into their investment decisions.

The trend in society calls for more ESG awareness and it is a self-reinforcing process. Society expects investors to enhance their ESG research processes and the resulting improvements in investment decisions create more momentum for the societal trends.

Worldwide, for many, ESG investing is still focused solely on creating a list of companies to exclude from a portfolio. Asset owners and asset managers will need to broaden their efforts away from simple exclusionary lists, as stakeholders increasingly expect true integration across an entire portfolio not just a small portion of the investable universe.

Millennials will force this change and we see this drive has already begun here locally with ESG questions coming from both Australian institutional and retail clients alike. As they grow older, this generation will demand ESG-integrated investments, as they are already asking about the ESG policies of the companies they do business with and their own employers. In addition, this new group of investors will demand competitive returns, as they don't believe societal value and financial performance have to be mutually exclusive.

 

Rob Wilson is an ESG Specialist and Research Analyst at MFS International Australia, a sponsor of Cuffelinks. This article is for informational purposes only and should not be considered investment advice or a complete analysis of every material fact regarding any investment.

1 Comments
Pablo Berrutti
April 12, 2018

Thanks Rob, nice article.

I like to think of ESG risks and opportunities across three dimensions:

- Industries - banks are different to mining companies,
- Location - a mining company operating in a Australia is different to one operating in Africa (regardless of where they are listed). Source of revenue and supply chain also important.
- Conduct/ethics - Does the company's behaviour give you more or less confidence that you can trust them with you capital? Could they be caught up in bribery or other issue.

While it's impossible to predict events like the oil and gas company story you use, you can get a sense of whether a company is more or less likely to run into issues based on their operating environment in these areas and the adequacy of their practices.

However, even when using a simple framework like this there can be dozens of relevant issues to consider. Tools like the Sustainable Accounting Standards Board's (SASB's) materiality map can help investors focus on key industry issues. https://materiality.sasb.org/

A host of other great tools are available to help with country and conduct risk analysis for these issues. You mentioned the Aqueduct tool which is excellent (and free!) http://www.wri.org/our-work/project/aqueduct. I have included some others I really like below.

Whether looking at general operating environment, risk assessment or company specific information ESG offers an important lens for investors and there are a host of great tools out there both free and subscription based.

The world bank has a range of country statistics on governance: http://info.worldbank.org/governance/wgi/#home
The global footprint network has open source data portal on environmental footprint:
https://www.footprintnetwork.org/resources/data/
The UN's human development index: http://hdr.undp.org/en/composite/HDI
Transparency international's corruption perception index: https://www.transparency.org/news/feature/corruption_perceptions_index_2017
And tools like the business and human rights resource centre which list human rights allegations against companies: https://www.business-humanrights.org/

 

Leave a Comment:

RELATED ARTICLES

The rise of socially responsible investing

Arms stocks don’t belong in our ESG funds

Beyond the acronym, navigating important ESG choices

banner

Most viewed in recent weeks

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Latest Updates

Investment strategies

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Investment strategies

Don't let Trump derail your wealth creation plans

If you want to build wealth over the long-term, trying to guess the stock market's next move is generally a bad idea. In a month where this might be more tempting than ever, here is what you should focus on instead.

Economics

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Investment strategies

Will China's EV boom end in tears?

China's EV dominance is reshaping global auto markets - but with soaring tariffs, overcapacity, and rising scrutiny, the industry’s meteoric rise may face a turbulent road ahead. Can China maintain its lead - or will it stall?

Investment strategies

REITs: a haven in a Trumpian world?

Equity markets have been lashed by Trump's tariff policies, yet REITs have outperformed. Not only are they largely unaffected by tariffs, but they offer a unique combination of growth, sound fundamentals, and value.

Shares

Why Europe is back on the global investor map

European equities are surging ahead of the U.S this year, driven by strong earnings, undervaluation, and fiscal stimulus. With quality founder-led firms and a strengthening Euro, Europe may be the next global investment hotspot.

Chalmers' disingenuous budget claims

The Treasurer often touts a $207 billion improvement in Australia's financial position. A deeper look at the numbers reveals something less impressive, caused far more by commodity price surprises than policy.

Fixed interest

Duration: Friend or foe in a defensive allocation?

Duration is back. After years in the doghouse, shifting markets and higher yields are restoring its role as a reliable diversifier and income source - offering defensive strength in today’s uncertain environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.