Many shades of green to ESG

By Jayson Forrest - Managing Editor  - IMAP Perspectives

Applying ESG and ethical frameworks within a portfolio, without compromising returns, might sound difficult. But for Karen McLeod CFP^® (Ethical Investment Advisers), Dan Powell (Nanuk Asset Management), Leah Willis (Australian Ethical) and Jason Todd (Macquarie), investing ethically is not as hard as it seems.

 Speaking at the 2021 IMAP Portfolio Management conference, a number of Environmental, Social and Corporate Governance (ESG) experts addressed some common misconceptions that advisers have about ESG and ethical investing. Here’s what they had to say:

Question 1: How do you initiate an ESG conversation with clients as part of the financial planning process?

 Karen McLeod: Advisers really need to draw upon their own experiences in order to talk about these ESG issues with clients. Globally, there are many companies already working very hard to be more sustainable. So, this is a great opportunity to take your clients on that sustainability journey because they can then become more engaged with the investments they are making, and feel they are making a positive difference to some of the global solutions we need to have, particularly if we are to get to net zero emissions.

 It all comes down to really getting to know your client. That’s why the FASEA regime is going to work so well, because we are being asked to lead from the front. And we are being asked to deliver solutions to clients that they didn’t even know existed.

 And when it comes to accessing information to make it easier for advisers to provide advice on ESG investing, a number of research houses and organisations provided ratings on ESG funds, which makes it easier to select appropriate funds.

 For example, Lonsec has the Bumblebee ratings system, while the leaf ratings system provided by the Ethical Advisers Co-operative (EAC) is a valuable and practical tool that provides advisers with a snapshot of which products have strong ethical screens and which products have poor ones. Advisers can then look at the financial ratings of these products, in addition to this ethical screen rating, to form a better picture of the universe of products available.

 There is a lot of research that advisers can subscribe to or access, but remember, research is only as good as the way in which you interpret it. Sometimes, the ESG score is not necessarily what your clients are seeking. Instead, they might be seeking alignment to social and corporate governance.

Adviser: Most of our clients are pre-retirees and retirees. We have found there is a significant difference between our clients in how they view what’s ethical and what isn’t. For example, many of our retiree clients are concerned about what is happening in Australia at a national level, like unemployment.

 So, when you start discussing ethical issues, these clients view companies from the perspective of what are they doing for Australians, and aren’t necessarily focused on how these businesses are operating environmentally.

 This then makes it really difficult for advisers to raise the issue of ESG with our clients. Therefore, it makes it all the more essential to find ESG and ethical resources to help us have these conversations with clients. However, most of the ESG investments available, do have a tilt towards environmental issues, and not necessarily to other areas that our clients are most concerned about.

 Karen McLeod: I agree, there is still a lot of information and education that needs to happen around ESG and ethical investing. For a start, you can go to the Responsible Investment Association Australasia (RIAA), which has a lot of information about funds that are targeting social issues. The RIAA provides regular updates about what funds have done environmentally and socially, in terms of corporate governance. 

 Leah Willis: When talking about employment, obviously, wages and jobs growth are very important for any economy. As a business, one of the things we are looking at right now is the commitment across the globe to climate change, and what that means for a high carbon-intensive marketplace or economy like Australia, which has been highly reliant on the resources and mining sectors for so long.

 There are many different views around climate change. However, we also need to acknowledge that many Australians are currently employed in the mining sector, particularly in Far North Queensland and Western Australia, and local communities depend on this sector. But, as an economy, if we don’t change and become greener, we will lose trading partners. So, that is an economic concern.

 One of the most interesting developments to come out of this debate are miners, like Andrew ‘Twiggy’ Forrest, starting to talk about ‘green steel’. While there is always going to be a carbon footprint and some sort of trade-off, if we can keep moving towards more sustainable solutions, hopefully, we will be able to get the economic fundamentals and the sustainability issues right.

 Adviser: I’d hate to think that the ethical investing community allows itself to be hijacked by the climate catastrophists. If they do, they’re going to gloss over a range of other issues that exist in international markets, like child trafficking and human slavery, that are important now, rather than something that might happen in 30 or 50 years.

 So, I caution against limiting the focus around environment and climate, particularly when you’ve got companies, like Apple and Nike, that are making product in countries where people are working under slave-type conditions. I think it’s appalling that we can’t get a broader perspective on this issue with ESG and ethical investing.

 Leah Willis: I completely agree. It comes back to the ‘shades of green’ with your approach to ESG, what your clients expect with ESG, and the values they want to line up to - such as, social issues and human rights issues - because modern slavery is a critical issue for most people.

 At Australian Ethical, we consider modern slavery. We look at labour and supply chain issues. We don’t invest in companies like Nike or Apple. In fact, last year, we were part of a market resolution on immigrant workers in the Woolworths supply and distribution chain. This resolution is about trying to change corporate behaviour.

 There are many broad and complex issues in the ESG and ethical space. Climate is one of these issues, but you’ve also got modern slavery and human rights, which are massive issues as well.

Karen McLeod: Clients aren’t really talking about nuclear energy, probably because we have so much sunlight for our solar energy needs, as well as an abundant of other natural resources, which clients prefer to invest in because they’re safer.

 Dan Powell: Nuclear energy is a complex issue. It is incredibly clean, but you only have to make one mistake and then you create intergenerational problems that can last thousands of years. Nanuk Asset Management has no uranium mining in our funds. The largest renewable energy company in the world, NextEra Energy - an American energy company - has some residual gas and nuclear holdings.

 However, what will probably kill the whole nuclear energy debate is not the challenges of nuclear energy, but the increasing cost-effectiveness of cleaner and more sustainable energy. In fact, what is driving the whole issue of sustainability are the economics that are currently being played out.

 Take, for example, my parents who had a solar hot water system in the 1970s. Solar has been around for many years, so why is it now so dominant? The answer is cost. The cost point has decreased, making solar more accessible and affordable to a greater number of people and industries.

 And with the capacity of batteries continuing to improve and dropping in price, you are going to see renewable energy eventually overtake nuclear, which will make the whole nuclear argument disappear altogether.

 So, the discussion around nuclear has nothing to do with being either pro-nuclear or not. Instead, it’s going to be a cost issue, which won’t be a bad outcome for consumers and the planet.

Karen McLeod: Advisers should consider joining the RIAA, which advocates for responsible and sustainable investing in Australia and New Zealand. The RIAA provides the accredited Responsible Investment Certification Program for advisers, which certifies that advisers have reached the professional standard required to advise on responsible investing products and services. There are a lot of factsheets and resources available on the RIAA’s website.

 There is also a co-operative of advisers that specialise in the ESG space - the Ethical Advisers Co-operative (EAC). This co-operative is a membership of financial advisers who predominantly provide ethical investment advice or are transitioning to this style of advice. The EAC rates funds that have an ethical or sustainability focus. These funds are considered to be making an effort to invest in more environmentally sustainable, ethical and socially responsible investments.

 Both the RIAA and EAC can help advice businesses and advisers put together a framework around ESG and ethical investing.

 There are also a lot of relevant articles about ESG on some of the education platforms, like Kaplan. Most fund managers involved in this space also have articles and resources available on their websites that advisers can access. And there’s also no shortage of academic pieces on this topic. Finally, don’t forget to talk to your dealer group, which probably gets inundated with research articles on ESG.

 So, my advice is to read widely about some of these ESG and ethical issues and decide where you stand as a business and where your clients stand as investors. It’s important to do this because ESG issues are nuanced. Therefore, you really need to work out your position, who you are serving, what your clients’ needs are, and also where you feel you can best put your expertise into practise.

 And make sure you do your own research. We have 30 funds on our short list just for this month to review. There is no shortage of product in the ESG space. In fact, there is a tsunami of ‘green’ products coming. So, you need to be very careful about what you are selecting for clients, because we have never seen so much activity in this space.

 You need to consider: what the fund is delivering; how does the fund differ from others; what’s the blending analysis; what’s the overlap; is the fund active or passive; how is the fund dealing with supply chain issues and with the stocks they own; and what’s the pricing like? There’s a lot to think about.   

 The good news is, the standards are rising with ESG and ethical investments. Previously, there were very bare minimum standards, but now the standards have increased dramatically, by including such issues as modern slavery and human rights violations.     

 Leah Willis: Some of Australia’s leading advice businesses - like Koda Capital, Crestone and some high-net-worth private wealth firms - have recently undertaken a 6-12 months process of building ESG policies into their portfolios. They have made a stance to have a discreet ESG policy across their investments. That’s because they see a rapid move towards ESG and ethical becoming mainstream with investing. The next step will be rolling out a dedicated socially responsible investment (SRI) model.

 When I first started out in the industry 25 years ago, there was a complete bias to U.S. and Australian equities. But if you look at portfolio construction now, it’s probably more diverse than it ever has been.

Karen McLeod CFP^® is a Financial Adviser at Ethical Investment Advisers; Dan Powell is Head of Distribution at Nanuk Asset Management; Leah Willis is Head of Client Relationships at Australian Ethical; and Jason Todd is Head of Wealth Management Investment Strategy at Macquarie.