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

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

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

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Taxation

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

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

7 key charts on the state of the Australian property market

The Australian property market stirs fierce debate - often bullish optimism versus crash predictions. But beyond the noise, seven charts reveal what's really driving prices and the outlook for residential real estate.

A simple alternative to the $3 million super tax

Division 296 aims to introduce improved fairness into the superannuation system, yet is overly complex. This scours the world for better ideas and suggests a simpler alternative which can achieve the same goals.

CBA and the index conundrum for super funds

After the hyperbolic rise in CBA shares, super funds are floating the idea of carving out the weightings of ASX bank securities and indexing them within their portfolios. This looks at why that might be a big error.

Strategy

10 policies to drive Australian productivity higher

Here's a comprehensive list of proposed reforms to fix Australia's stagnating economy, including introducing a flat income tax rate, reducing migration, and making childcare tax-deductible.

Interviews

Where to find big winners in Asia

As more money looks for a home outside the US, Asia may soon get some love. Fidelity's Anthony Srom outlines the best places in Asia to invest, including in Chinese consumer names, Indian financials, and Thailand.

Investment strategies

We have trouble understanding the time value of money

We overvalue the present and underestimate the future - it’s a cognitive glitch called hyperbolic discounting. It affects savings, spending, and loans, and it's more common - and costly - than we think. 

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.