Beyond 60/40: ESG: A balance of ideology and thesis

By Jayson Forrest

Dianna Enlund (S&P Global Sustainable1) and Mark Jordan (Nanuk Asset Management) consider the difficulties in constructing portfolios for clients with responsible objectives that sit outside the traditional 60/40 framework

It can be challenging for advisers to build portfolios for clients with responsible objectives. There are many issues to navigate, ranging from access to quality data, greenwashing, through to investment objectives that align with the client’s goals.

According to Daniel Stojanovski — Chief Investment Officer at Ventura Funds Management and Asset Consultant to Centrepoint Alliance — environment, social, and governance (ESG) investing is “very client-specific”. He believes that from an investment perspective, the best way to approach ESG is to start with a clear philosophy, which then leads to investment objectives and what you’re trying to achieve in the portfolio.

“When allocating to ESG, it’s important to remember you’re still trying to achieve an investment objective over a specific timeframe. You need to be clear about the types of ESG objectives you’re trying to target for the client, like investment exclusions in certain areas. This is where the investment process becomes important,” says Daniel.

Speaking on the topic of ‘ESG’ as part of an IMAP webinar series titled ‘Beyond 60:40 — Delivering portfolios for clients with different goals’, Daniel believes when building portfolios, exclusionary strategies (exclusions like tobacco and weapons) and impact-type strategies (where a company is aiming to achieve a specific ESG goal or create positive change) allow clients to invest in companies that align with their personal ESG objectives.

Dianna Enlund — Sustainability Solutions Director for S&P Global Sustainable1 — believes investor appetite for ESG investments continues to grow rapidly, pointing to a 2024 survey by the Responsible Investment Association Australasia (RIAA), which reports that 88 per cent of Australians expect their investments (like superannuation) to be invested responsibly and ethically.

“This is why it’s important for advisers to understand a client’s sustainability needs and preferences, because increasingly, we’re seeing consumers wanting their investments to be invested sustainably,” says Dianna.

It’s a view shared by Mark Jordan — Senior Business Development Manager at Nanuk Asset Management — who says despite some complexity and issues (like greenwashing) around ESG and sustainable investments, investor demand in ESG strategies continues to grow. He also believes investor awareness of ESG is particularly strong amongst the younger demographic.

“The RIAA research suggests there is an opportunity for advisers to engage with their clients on ESG, because I don’t believe advisers are having these conversations with 88 per cent of their client base,” he says. “As the younger demographic starts moving through the investing lifecycle, we can expect to see demand for ESG solutions shift higher.”

It’s a view Dianna supports: “The younger demographic will drive the growth of ESG. They are more aware of ESG issues, which will invariably have an impact on them during their lifetime. Overtime, I do believe sustainability will become more embedded in the overall investment process.” 

According to Mark, many asset managers have already integrated ESG risk as part of their investment and/or risk management policy. This means companies demonstrating a negative impact in relation to the environment (carbon emissions and pollution), social (poor labour practices and human rights issues), or governance (business ethics and integrity), are essentially putting at risk the future cashflows of their business. Understandably, that can affect portfolio outcomes over the long-term.

“Most investors have an expectation that investment management teams are considering these risks,” says Mark.

Nanuk believes the focus on ESG investing should be on what a fund does invest in (the investment strategy), and not necessarily their ESG ideology in what not to invest in. And when it comes to managed funds, this is where Mark believes the ESG acronym has become overloaded.

“ESG is a broad and diverse universe that means different things to different people — from exclusions to ethical screening, through to risk management and active ownership.”

In fact, Mark believes the biggest challenge facing the industry is the issue around some of the terminology used in ESG, particularly in relation to using the ESG term to describe a range of different investing approaches. Mark says this has caused confusion and misunderstanding for advisers and clients when looking at different investment options that align with their objectives.

“So, when considering ESG, we need to shift the focus from ‘labels’ and ‘scores’, and instead, look at what’s driving the long-term value and risk in a portfolio.”

To do that, Mark says advisers need to consider the strategy of each individual fund. He says there are approximately 600 different ESG standards and frameworks that are being used globally, with the majority of these falling into just seven categories:

• Not investing in companies doing bad things.
• Investing in companies with better governance, or even just considering governance in the investment process.
• Encouraging companies to improve their governance or sustainability.
• Investing in companies that are doing things that help improve sustainability.
• Investing in companies with low carbon emissions.
• Investing in companies whose activities are aligned with global decarbonisation.
• Investing with the intent to achieve measurable social or environmental outcomes.

“All these categories are referred to as ‘ESG investment’ but clearly, there are seven different approaches to ESG investing. In many cases, these strategies can be combined but they’re not entirely compatible.” 

For example, one ESG strategy might invest in businesses with low carbon emissions, while another strategy might invest in high emission companies (oil and gas), but seek to engage with those businesses to lower their emissions and become more sustainable.

“The term ESG, including responsible investment, should not be used to represent a single concept, because it simply doesn’t,” says Mark. “Investor confusion arises not so much from a strategy, but more as a mismatch between what a client expects and what a fund actually delivers. So, it’s critical to ensure there is alignment between the client’s personal objectives and the fund’s investment strategy.”   

According to Mark, responsible investment is inherent in Nanuk’s investment philosophy, where it focuses on investing in industries and technology that are contributing to, or benefitting from, the global transition towards greater environmental sustainability.

“A fund investment strategy needs to be clear and credible. Ideology alone won’t provide the investment returns demanded by investors,” says Mark. “You need to have a process — like an effective sustainability and ESG-based exclusions framework — that can identify long-term value creation to drive the outcomes.”

Mark believes that by replacing industry jargon around ESG with plain language descriptions, advisers will be better placed to engage with clients to bridge the gap between investor objectives and the different investment approaches that funds take.

He offers the following plain language descriptions that he believes are more relevant to understanding what it is that clients want to achieve with their investments, including how they want to align their investments, values and beliefs.

Table 1: Replace ‘ESG’ with plain language descriptions:

Mark believes a framework for talking to clients about ESG investing should start by asking about the social and environmental causes they care about. For example, are there specific industries they want to avoid? Do they want to invest in companies that are making a real difference?

“Advisers need to educate their clients about the wide spectrum of investments in the ESG space, while explaining how funds actually implement their respective strategies. Advisers also need to show evidence (like reporting) that demonstrates alignment between the client’s values and the investment strategy,” he says.

“And as with any investment, a regular review process is critical. This means sitting down with the client to ensure that the investment strategy still aligns with the client’s values and goals. It’s never a one-off conversation.”

An important consideration with ESG investing are the mandatory climate-related financial disclosures, which came into effect on 1 January, 2025. This means that many large Australian businesses and financial institutions are now required to prepare annual sustainability reports containing climate-related financial disclosures.

The disclosure framework is based on four pillars — governance, strategy, risk management, and metrics and targets. Dianna says the part that most people are interested in are the metrics and targets that companies are required to report on. These include: greenhouse gas emissions (Scope 1, 2 and 3), transition and physical risks (companies need to report the dollar amount and percentage of assets, or business activities, that are vulnerable to transition and physical risks), and climate-related factors (including whether companies have internal carbon pricing, and the proportion of executive management remuneration that might be linked to climate-related metrics, such as a reduction in emissions).

“These are the types of metrics that are required by companies, which could affect their cashflow, their access to finance, and cost of capital over the short, medium and long-term. This mandatory climate-related financial disclosure reporting makes it very relevant for funds management, because if a company is exposed to a physical or transition risk that can impact their cashflow or their ability to access capital, they’re likely to have stranded assets in the future,” says Dianna.

“These requirements also make it necessary for investment managers to understand what those risks are for businesses, as well as what the potential opportunities are for companies in relation to climate change. So, by mandating standardised regulatory reporting, it provides investors with information that is consistent and comparable, enabling them to assess the impact of climate change on companies. This will enable investors to invest in funds and companies more efficiently and in a more informed way.”    

When it comes to investor understanding of ESG investment strategies, Mark believes there are some platforms that do provide a reasonable amount of information in relation to “what’s underneath the bonnet” of some of these strategies. However, he believes there is still a lot of confusion amongst investors when it comes to assessing different fund strategies.

“We see managed account model portfolios that have a sustainable or responsible investment badge on them, but when we’ve looked closely at some of the funds in those portfolios, we don’t know why they’re there, despite approval from some highly respected research houses,” says Mark. “So, I still think there is a long way to go when it comes to understanding how certain funds are actually investing.”

Therefore, while ESG scoring is useful, Mark encourages advisers to engage closely with fund managers to ensure the fund is aligned to the right objectives, while delivering returns.  

“Unfortunately, greenwashing is still an issue for the ESG and sustainable investing sector. Advisers need to avoid that trap by being aware of the funds they’re investing in. Transparency is key to investing, so if you’re not getting the information you need from the fund manager, then maybe that fund is not right for you.”

Dianna dismisses any assertion that investing in ESG means giving up returns and accepting a lower level of portfolio performance. She points to data from various indices (including the S&P/ASX 200 Index, the S&P/ASX 200 ESG Index, and the S&P/ASX 200 Carbon Efficient Index) which show that the returns of the sustainability indices have been aligned, if not slightly higher, to the parent index. “This shows you don’t have to give up returns to invest sustainably,” says Dianna.

However, if the returns are fairly similar, does that mean investors are taking on higher risk by investing in ESG?

“Not so,” says Dianna. “Our data across these three indices show that the risk-adjusted returns for three, five and 10 years shows that the Carbon Efficient Index has similar risk-adjusted returns to the underlying S&P/ASX 200 Index, while the ESG Index has slightly improved risk-adjusted returns. So, by looking at this data, it’s clear that investors who choose to invest sustainably are not taking on higher risk.”

Not surprisingly, companies operating a more sustainable business or in a sustainable industry, will be beneficiaries of long-term tailwinds, says Mark. However, he cautions that like any investment, investors shouldn’t rush blindly into the ESG sector and expect to receive superior returns. Just like any investment, there are always going to be winners and losers.

“Investing in this space is not about ideology, the investment thesis must also stack-up,” he says.

Dianna Enlund is Sustainability Solutions Director for S&P Global Sustainable1; and Mark Jordan is Senior Business Development Manager at Nanuk Asset Management.

They spoke on the topic of ‘ESG’ as part of an IMAP webinar series titled ‘Beyond 60:40 — Delivering portfolios for clients with different goals’.

The session was moderated by Daniel Stojanovski — Chief Investment Officer at Ventura Funds Management and Asset Consultant to Centrepoint Alliance.