Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 391

Why ESG assessment must now consider active ownership

In 2020, as COVID-19 caused markets to whipsaw in response to economic recovery, vaccine and immunity hopes, the job of analysts assessing long-term asset value became far more complex and fast-moving.

The accelerated rate of change brought on by COVID also sped up critical investment decisions, highlighted the importance of Environmental, Social and Governance (ESG) considerations and expanded the discussion to include responsible investing and active ownership.

Social risk and active ownership questions

The year began with the enormous loss and hardship associated Australia’s bushfires. Summer brought another wave of COVID and more lockdowns. Not surprisingly, client interactions throughout 2020 touched on one, if not all, aspects of the ever-growing ESG issues. Questions on social risk, such as human welfare, supply chain and climate, as well as reputational risks, are now at the forefront of the investment discussion.

This has moved the ESG conversation beyond E, S and G factors and their application and integration into valuation models to what they need to be anchored to in order to drive change, which is active ownership.

The Principles for Responsible Investment (PRI) defines active ownership as the ‘use of the rights and position of ownership to influence the activities or behaviour of investee companies’, that is to say, the use of ESG engagement and proxy voting.

Regardless of how an investor chooses to own an asset, ownership is ultimately an undertaking to knowing a company’s business, and how the company is positioned for growth is essential to understanding its sustainability over the long term.

This was truer than ever in 2020 as businesses found ways to help their stakeholders deal with multidimensional crises such as COVID that overnight turned the world virtual, forcing individuals, families, communities, organisations, states and markets to interact in ways and on a scale never seen before.

The role of passive and active managers

Both passive (index) and active managers have an important role to play in realising the potential value that thoughtful engagement and proxy voting can create. While large passive managers have the size to influence voting on broad issues, their ability to effect nuanced engagements with companies is likely hindered simply because they own so many companies. Index investors generally have to buy all the companies in the relevant benchmark.

Typically, active managers are better positioned to look into businesses, industry operations and management. They use all the available information, including non-financial information (which is becoming increasingly mandated), to determine what will have a material impact on those businesses.

If they do not know the business well enough, they cannot tell the difference between one that is sustainable and socially responsible or not. Nor are they able to effectively challenge company management on how to deal with ESG risks and take advantage of ESG opportunities.

Active investors with deep research capabilities are able to perform 'materiality discovery' similar to price discovery and engage in a sustained way with investee companies to instigate change.

Research from Cambridge University shows that:

"ESG engagements generate cumulative size-adjusted abnormal return of +2.3% over the following year on the initial engagement. Cumulative abnormal returns are much higher for successful engagements (+7.1%)."

The research found no market reaction to unsuccessful engagements.

Investment organisations that manage sustainable investing through ESG integration, proxy voting and engagement are more likely to create sustainable value over the long term.

In addition, these active ownership attributes improve their ability to achieve their client’s objectives and meet their fiduciary responsibilities. We have yet to be convinced that offering products with ESG screens or overlays can do the same, perhaps it ticks a short-term box, but true long-term stewards should demand more.

ESG risk assessment a blunt tool

In our experience, investors want to know what longer-term, sustained improvement in the relevant ESG areas a company has made. Whilst we understand why transparency and measurement is important, we caution against an over reliance on narrow or blunt measurement tools, which cannot be expected to capture the nuance and range of the ESG risks faced by, and opportunities available to, companies.

The chaos in the marketplace in relation to assessing companies for ESG is well illustrated below. The world’s largest rating agencies, FTSE and MSCI, are virtually uncorrelated when it comes to ESG materiality. This creates an opportunity for managers such as MFS to engage with clients on how the criteria that we, ourselves, have been building can potentially drive long-term performance on their behalf.

 


Register here to receive the Firstlinks weekly newsletter for free

ESG must include active ownership

Client alignment is at the heart of active ownership, so a critical part of the ESG discussion is to understand whether your investment manager is aligned with your views and how sustainability is factored into the investment process undertaken.

Active ownership will become a necessity and the norm for all managers, both active and passive. There is a chance that that passive owners, not passive managers, will get punished if they do not use their voting power to build more sustainable practices at companies.

At a time when we are facing more pressure and complexity than ever before, the managers who survive will be those that align with their clients' long-term needs and support the transition to a more sustainable society. This philosophy fuels our beliefs as an active manager.

 

Marian Poirier is Senior Managing Director, Australia for MFS Investment Management. The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.

 

RELATED ARTICLES

Amid vaccine hope and skepticism, testing is key

The role of financial markets when earnings are falling

Australia's baby boom filling some of the immigration losses

banner

Most viewed in recent weeks

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Latest Updates

Retirement

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Property

Hey boomer, first home buyers and all the fuss

What is APRA worried about? Most mortgagees can easily absorb increases in interest rates without posing a systemic threat to the banking system. Housing lending is a relatively risk-free activity for banks.

Property

Residential Property Survey Q3 2021

Housing market sentiment has eased from record highs and confidence has ticked down as house price rises slow. Construction costs overtook lack of development sites as the biggest impediment for new housing.

Investment strategies

Personal finance is 80% personal and 20% finance

Understanding your own biases and behaviours is even more important than learning about markets. Overcome four major cognitive biases that may be sabotaging your investing and recognise them in others.

Where do stockmarket returns come from over time?

Cash flow statements differ from income statements and balance sheets, and every company must balance payments to investors versus investing into the business. Cash flows drive the value of the business.

Fixed interest

How to invest in the ‘reopening of Australia’ in bonds

As Sydney and Melbourne emerge from lockdown, there are some reopening trades in the Australian credit market which 'sophisticated' investors should consider as part of their fixed income portfolios.

Shares

10 trends reshaping the future of emerging markets

Demand for air travel, China’s growing middle-class population, Brazil’s digital payments take-up, Indian IPOs, and increased urbanisation are just some of the trends being seen in emerging economies.

Sponsors

Alliances

© 2021 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. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). 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.

Website Development by Master Publisher.