FAVOURITES: 22 November 2011 –At the Colonial First State Global Asset Management Responsible Investment Forum earlier this year chief executive officer Mark Lazberger expressed frustration over the investment industry’s short term focus, saying it was inhibiting consideration of environmental, social and governance, or ESG, issues in capital allocation and holding back company and investment performance
“We’d like to see a greater number of investors considering ESG risks and we believe the investment industry has a role to play in encouraging companies to make the required changes,” Lazberger said.
“Positively, investors are increasingly becoming alert to the importance of ESG issues and are challenging the industry to incorporate these considerations into the investment process. As a consequence, we expect capital allocations will be made more efficiently over time,” he said.
ESG issues have been top of mind for CFSGAM for some time. A wholly owned division of the Commonwealth Bank, CFSGAM has been gradually building up its ESG credentials with a particular focus on the quality of its team of responsible investment specialists. And over the past 18 months it has integrated ESG principles across every aspect of its business.
The strategy appears to be paying dividends, with one of CFSGAM’s listed property funds, the Commonwealth Property Office Fund, recently ranked number one in the Global Real Estate Sustainability Benchmark survey of the environmental and social performance of 340 of the world’s largest property companies.
In early November the fund (together with Westpac) also topped the Carbon Disclosure Project’s report for its carbon disclosure score and performance, receiving a score of 96 for disclosure and an A for performance.
But does this also translate into superior investment performance?
Amanda McCluskey, CFSGAM’s head of sustainability and responsible investment, believes it does. She points to the fact that 78 per cent of CFSGAM’s Australian equity funds outperformed their respective benchmarks over a three year period (and 69 per cent and 73 per cent over one and five years, respectively). All of these integrate responsible investment into the investment process.
In global emerging markets, where CFSGAM puts a strong emphasis on ESG considerations, 100 per cent of its funds have beaten their benchmarks.
“Direct attribution to performance is always a challenging thing to demonstrate, given the integrated nature of our approach. However we believe our approach to responsible investment has been a factor in our solid investment performance,” McCluskey says.
In direct property, while it is difficult to attribute outperformance to an ESG focus, the integration of ESG into the investment management process is one way of improving management quality, McCluskey says.
This allows funds to maintain and increase their value, and also to maintain an income stream through high occupancy levels. She points to the high occupancy levels of CFSGAM’s two Australian listed property funds, the Commmonwealth Property Fund and CFS Retail Property Trust, of 99.7 per cent and 96.7 per cent, respectively.
Also supporting the link between ESG factors and investment performance is recent research by CFSGAM that revealed the top rated ESG stocks in its Global Listed Infrastructure portfolio outperformed the bottom-rated stocks by more than 20 per cent over a three year period.
But it is not just about investment returns.
Protecting clients against the inherent risks of ignoring ESG issues is just as important, McCluskey says. She believes there is still a level of misunderstanding within the industry regarding the difference between socially responsible or ethical investing and integrated ESG management.
“Our approach to responsible investment doesn’t screen out particular companies or sectors based on socially responsible or ethical strategies. Instead, ESG issues are considered in the same manner as traditional financial issues,” says McCluskey.
“We take this approach because pricing sustainability issues into every investment decision allows us to protect our clients against ESG-related risks and enhance the investment performance of our funds.”
As part of her role, McCluskey visits overseas markets to research how sustainability challenges are being addressed globally.
“The challenges and the way they are tackled differ in different markets. In India there is more consideration of intergenerational equity – they think about the impact of their actions on their children and grandchildren. Here and in the UK we talk much more about the next 12 months.
“There are differences in social conscience in each country,” says McCluskey.
- See Amanda McCluskey’s article in The Fifth Estate, India and the Road to Sustainability
- David Gait’s Sustainable Investment Lessons from India
At the same time, developed nations are contributing expertise and innovation to developing nations. For example, in Jakarta European multinationals are influencing sustainable development practices and introducing innovative building products and techniques.
Occupy movement signals shareholder mistrust
According to McCluskey a trend that is spreading globally is the pressure from shareholders for more accountability and higher ethical standards.
“The Occupy movement is making us think in the financial sector. Now mainstream shareholders are getting upset and they will continue to put pressure on corporations to be accountable,” McCluskey says.
“Pension funds need to think about this in terms of their liabilities. There is a mismatch between the aspirations of shareholders and those of many super funds. There has been a push from some within the industry to address this mismatch for the past 10 years but now there is pressure from the ground up. Regulators around the world will need to act to correct this.”
CFSGAM is doing its best to spread the message. First, it got its own house in order, integrating sustainability across the business by building performance metrics into its strategic planning process and defining success as incorporating the six United Nations’ principles of responsible investment into all areas of the business.
Longer time frames for the investment team were set with three year instead of 12 month targets.
As a signatory to the United Nations Principles of Responsible Investment, it set targets for attaining top quartile ranking across the six principles – so far it has achieved this in all but the second of the six principles, up from three quartile one rankings the prior year.
The business is ranked in the second quartile for the second principle.
The next task is to push the message through the investment supply chain by actively engaging government and the business and investment community to drive improvements in ESG related practices.
The six principles of responsible investment are:
1 We will incorporate ESG issues into investment analysis and decision-making processes.
2 We will be active owners and incorporate ESG issues into our ownership policies and practices.
3 We will seek appropriate disclosure on ESG issues by the entities in which we invest.
4 We will promote acceptance and implementation of the Principles within the investment industry.
5 We will work together to enhance our effectiveness in implementing the Principles.
6 We will each report on our activities and progress towards implementing the Principles.
See the website for full details
The investment supply chain and ESG
One of the hardest investment areas for engagement is fixed interest and credit.
Nick Edgerton joined CFSGAM as manager ESG research and engagement 18 months ago, moving across from a role in sustainable investment at AMP Capital. He has been reviewing the role of counterparties on credit and fixed interest and says the nature of this financial category makes engaging investors and credit providers on ESG particularly challenging.
“When integrating ESG issues into equity investment you are looking at risk opportunities on downside share price as well as upside, but with credit you are only exposed to downside risk through default risk.
“The question to ask is how does ESG contribute to the risk of default,” Edgerton says.
Credit and fixed interest analysts have a good understanding of how corporate governance can impact on financial performance because of the widespread collapse of companies during the GFC.
“The real challenge is finding how environmental and social risks flow through to investments. We don’t have enough understanding on the downside – the focus is on upside and better performance.
“There are particular risks when investing in operations offshore, particularly in emerging markets if a business’s interactions with the communities in which they operate are poorly managed.”
There are definite opportunities for companies operating in emerging markets to manage this process better. Issues to address could be bribery and corruption in management and environmental impacts of the operations.
Another challenge of credit and fixed interest is the engagement process. In equities an investment manager typically gets access to the company CEO or chairman, whereas in credit there is no shareholder relationship so engagement access can be difficult.
“Credit analysts historically do internal research and are not necessarily swayed by what a company says so engagement doesn’t factor into the process. Where you do get to talk to someone it is usually head of treasury and they have a very different view of the operation and risk. A CEO will have a broader view of the operation as a whole. This can influence the way an analyst views the area as well.”
Credit and the downside risk of ESG
One area of the credit supply chain Edgerton is looking at is the big four Australian banks.
“We’re talking to chief risk officers in the banks to get an idea of the risk on their balance sheets from ESG issues. We focus less on the type of buildings they occupy and their overall carbon footprint and more on whether they are financing businesses that face environmental headwinds in the future. Are they developing policies for lending to businesses in the forestry, water and utilities sectors?
“Our focus is getting an idea of an organisation’s long term financial exposure to environmental and social risk,” says Edgerton.
Sovereign bonds is another area of focus. In October the UN Environment Programme Finance Initiative and the Global Footprint Network launched a project to measure how the environmental footprint of a country impacts on sovereign bond performance (https://www.unepfi.org/events/2011/ecorisk_projectlaunch/index.html) Edgerton hopes the research will throw more light on the area for investors.
“Currently when investors are looking at sovereign bonds there is very little understanding of how a country’s social and environmental rating flows through to the rating of its sovereign bond.”
Edgerton says that despite the difficulty of getting the ESG message through in credit and fixed interest there has been progress. Asset consultants, for example, are now starting to rate credit and fixed interest in regard to ESG issues for the first time.
Property – first the human aspect, then capex
In property, CFSGAM has been concentrating on a gradual program of sustainable upgrades across its office portfolio says Rowan Griffin, head of sustainability, property.
Most of the properties are existing buildings and the emphasis is on cost effective upgrades with a return on investment time frame of three to five years.
Every investment is looked at in terms of sustainability, both environmental and social. This is factored into the investment process and is always front of mind, Griffin says.
“We incorporate sustainability across all our investments but we are here as a fiduciary and investment returns are our priority. We have long term asset planning in place with a NABERS rating on every property.
“By having a focused program we chip away over time. We are not going to replace chillers where they have a 20-year life. First we address human behaviour and how this contributes to the efficiency of buildings – then we move on to capex [capital expenditure].”
Reaching and maintaining a four and a half star or five star NABERS Energy rating is reasonably easy but anything higher is not realistic, he says.
“Unless you buy green energy a six star is just not realistic and we do not believe in buying green energy – we want actual performance in our buildings.”
CFSGAM also includes a green lease schedule in every commercial lease which encourages tenants to help maintain the NABERS rating and to get a Green Star Interiors rating.
For its retail properties return on investment needs to be three years.
“Anything less than that we have to look at very carefully,” says Griffin. “We haven’t got the tenant demand to justify more.”
In shopping centres the ESG emphasis is increasingly about social aspects and what the centre gives back to the community. Providing space for community groups rent-free and incorporating green transport plans are common. Where feasible, green technology is used in centres, such as photovoltaics on the roof.
Griffin has seen a change in the way analysts of listed property are viewing ESG initiatives.
“Sustainability was never on the radar for analysts before. Now they see the risk for property in not acting and they are looking at it more and more. It is still not that material to them but they are starting to look at it,” says Griffin.
According to McCluskey the same is happening in infrastructure, with valuers now talking about the value of ESG to projects. With the carbon tax, energy infrastructure will also focus on ESG much more.
“There are very few infrastructure valuers but those who do specialise in it are starting to look at how to value community engagement,” McCluskey says.
“Social issues are always the poor cousin to environmental sustainability as these things are hard to measure and are often more about gut feel. But investors are looking at these issues more and more.”