Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 298

ESG by new means, to new ends

As shareholders question ESG (Environmental, Social and Governance) practices more than ever, we spoke to some institutional clients about how they are thinking about ESG when managing their funds. From reducing emissions to corporate culture and ESG risk assessments, the conversation highlighted the industry’s approach is not uniform but we are all grappling with the same issues.

Carbon production dominated client discussions

Depending on how you measure carbon, especially emissions versus intensity, a portfolio can yield different results. When it comes to portfolio construction there are two schools of thought: exclusion and inclusion.

On the one hand, excluding carbon producing companies in a smart beta portfolio lowers the environmental impact of the overall portfolio but may create an unintended sector bias. Allocating more funds to low carbon sectors can result in unintended tracking errors.

On the other hand, an actively-managed portfolio might invest in carbon-producing companies that have sensible action plans in place. Once these companies have achieved an emissions reduction, or steered their operations towards a more sustainable future, they generate long-term value and good returns for their investors.

As fund managers, we have a clear responsibility to avoid the worst impacts of poor ESG management to minimise the risk of losing client capital. As seen in the starkly different approaches to carbon emissions, there is not necessarily a single or correct way of mitigating ESG risks.

Credit risk analysis should focus on ESG as well as default risk

Identifying ESG risks requires a constant scrutiny of past and present decisions. Our analysis shows a strong relationship between our ESG analysis and our internal credit ratings. In 2018, 40% of our internal credit ratings were lower than those of credit rating agencies S&P and Moody’s*, with 60% of these being rated high or very high ESG risk. This highlights a potential underweighting of ESG issues by the market.

However, 30% of our internal credit ratings were higher than S&P and Moody’s ratings in 2018*, which again is partly a result of companies taking steps to address ESG risk and implement safeguards. ESG in fixed income has mostly been focused on the risk of default, however a company’s ESG practices can also give investors greater confidence in the quality of management and the business, positively shifting the risk versus return ratio.

We believe our strong ESG processes have contributed to our global credit income strategy having an average BBB security rating but delivering below AA default outcomes.

Research should scrutinise each issuer on a case-by-case basis against a range of ESG metrics. The risks are different in every sector. Warning signs range from safety lapses, regulatory fines and environmental breaches. In the electronics industry, investors should look for any signs of exploitation in a factory's supply chain, while the biggest area of scrutiny for banking is lending policies.

If it appears a company is managing any of these visible risks poorly, then we don’t have confidence in other risks being well managed. This interactive case study map includes over 100 examples from across our business.

One recent example was our raising Woolworth’s ESG risk assessment from low risk to moderate risk. While Woolworths has commendably exceeded its target to reduce carbon emissions and has partnered with Replast to address plastic waste, we hold concerns over the risks associated with allegations of underpaying employees found by the Fair Work Ombudsman. We anticipate that ongoing legal action from the Retail and Fast Food Workers Union, which is seeking damages of over $1 billion in back pay, could trigger a structural change.

Ethical sourcing of products such as palm oil and seafood also remains a concern, but due to investor pressure and the Modern Slavery Act, policies are being adopted by Woolworths to improve the social supply chain standard. We believe governance could be enhanced by aligning compensation with ESG factors.

Corporate culture often needs addressing to support successful ESG practices. ESG is more than making a statement about carbon reduction or unveiling a new social policy. ESG should be at the heart of everything that a company does and its corporate culture should serve as an incubator for lasting change.

These examples show that regardless of whether it is a smart beta strategy investing in thousands of companies or through bottom-up company analysis in a credit fund, ESG factors can be a powerful investment consideration that can deliver sustainable long-term returns and better social and environmental outcomes.

* Source: CFSGAM, Investment Opinion Network as at 31 Dec 2018. Moody's and S&P annual default studies, based on number of issuer defaults.  Averaged cumulative defaults since 1983.

 

Pablo Berrutti is Head of Responsible Investment, Asia Pacific and Mark Nieuwoudt is a Business Development Strategist at Colonial First State Global Asset Management, a sponsor of Cuffelinks. This article is for general information purposes only and does not consider the circumstances of any individual (view full disclaimer here).

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

 

  •   20 March 2019
  • 1
  •      
  •   

RELATED ARTICLES

Top 10 ESG issues for 2019

UNPRI ready to go to the next level

Beyond the acronym, navigating important ESG choices

banner

Most viewed in recent weeks

Why have Australian living standards 'fallen' and how do we fix it?

For the last few years there has been much talk of a 'cost-of-living' crisis in Australia and of 'falling living standards'. Lately this has flared up again with the pickup in inflation resulting in a renewed fall in real wages.

Will you run out of money in retirement?

Fear of running out has become a defining retirement anxiety. Why do some retirees die with substantial wealth while others deplete their nest egg? Evidence suggests the answer is more complicated than we think. 

Four options for an income investor’s next dollar

What if Australia’s golden age of dividends is ending? Rather than overhaul your portfolio, it may be worth considering where new capital can work harder. I discuss four income strategies and the trade-offs behind each.

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

The investment that sidesteps the new tax traps

Tax rules have changed, but many investors are still using yesterday’s strategies. Insurance bonds may offer advantages for those seeking greater control, tax efficiency and certainty about their wealth.

Testamentary trusts have secured the CGT exemption

Treasury’s latest CGT reform draft delivers a win for testamentary trusts and deceased estates, exempting estate-derived gains from the 30% floor. However, questions on death and divorce rollovers remain unresolved.

Latest Updates

Shares

Is it time to bail on Australian stocks?

For generations, Australian investors have backed banks, miners and dividends. But has that loyalty come at a cost? A look at the numbers raises an uncomfortable question about where future returns will come from.

Investment strategies

Making a case for the 40 year mortgage

The housing debate tends to focus on prices, interest rates and deposits. Yet an overlooked feature of the mortgage itself could help buyers enter the market sooner without abandoning prudent lending standards.

SMSF strategies

Red flags to watch out for when considering an SMSF

Thinking about an SMSF? Before you sign anything, learn how to spot the difference between genuine advice and a sales pitch, understand the real costs, and avoid the compliance mistakes that attract ATO attention.

Investment strategies

Not all income is created equal

Market conditions are shifting as familiar yield sources quietly lose momentum. Australian public credit may be the most compelling source of income in today's market but many investors haven't noticed the shift. 

Investment strategies

The market paid for change, not comfort

Reporting season has delivered a clear message: the market is no longer paying simply for quality, resilience or an earnings beat. It is paying for change in earnings expectations and the outlook ahead. 

Investment strategies

Will AI destroy investor capital?

Some of history's most important innovations changed the world while leaving investors much poorer. As trillions pour into AI, a familiar pattern may be emerging, one that rewards society far more generously than capital.

ASX reporting season: Signals, surprises, stock stories

August reporting season delivered strong earnings and bigger-than-expected dividends, but beneath this, a more nuanced story emerged. First Sentier Investors’ David Wilson and Christian Guerra unpack the key trends.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 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.