Three ESG Questions for Retail Investors in 2021

This year, Environmental, Social and Governance (ESG) investing continued its meteoric rise. The 2020 RIAA investor survey found that $1,149 billion– 37 percent of all professionally managed assets in Australia — is now dedicated to responsible investment in Australia with 87% of responsible investment managed using ESG investment processes.

While ESG investing, with its ESG-related shareholder resolutions and push for greater disclosure on key risks, can be seen as the domain of large, institutional investors such as superannuation funds, the size of ESG investing now means that ESG investment issues impact all investors. Retail equity investors with their flexibility in choosing equities and smaller percentages of ownership will be impacted by the decisions made by large, institutional investors moving towards greater ESG investment as well as the rise of impact investing. Overall, ESG will continue to make the public markets more diverse and complex as companies, creating new opportunities and risks for retail investors in 2021.

There are, in our view, three key ESG-related questions for retail investors in 2021. How will retail investors be impacted by the $247 billion of REST, Cbus, HESTA and UniSuper that has been committed to being invested in net zero portfolios by 2050? What resources are available for small retail investors to understand and investigate the growing number and sophistication of ESG-related shareholder resolutions? Finally, will impact-first investing, currently growing in private markets and alternative asset, come to the public markets?

In November 2020, REST Super, a $57bn superannuation fund, settled a court case with a member who accused it of failing to act in his best interests by not properly considering the risks the climate crisis poses to investments. The settlement required the fund to ensure its actions are consistent with a “net zero carbon footprint” by 2050, and showed that any long-term asset owner may face compelling legal action on its climate integration strategies (or lack thereof). REST has now joined other major superannuation funds, including Cbus, HESTA and UniSuper, that have committed to aligning their portfolios with net zero by 2050.

Net zero is a commitment to achieve net-zero carbon emissions. This can be achieved by divesting from fossil fuel industries, financing clean energy, working with emissions intensive industries to reduce emissions and commitments to climate initiatives. The overall aim is to help reach the Paris Climate Agreement to limit global temperate rise to 2 degrees Celsius above pre-industrial levels.

In our view, more superannuation funds moving to net zero will restrict the access to capital for high-emissions companies in public equity markets. Superannuation funds (and their asset managers) targeting net zero will push capital towards lower-emissions businesses. In order to raise capital from net zero companies, high-emissions businesses will have to include emissions reduction targets as part of their capital-raising pitches. Companies that provide emissions reduction solutions to other companies will have committed supporters in the net zero superannuation funds. The result will be a ‘greening’ of the public equity markets over time.

To better understand the investment risks and opportunities, retail investors can use resources such as the Inevitable Policy Response (IPR) report, available free through the Altiorem sustainable investment library. The IPR is a guide for investors that matches the forecast impacts of climate change to a likely set of major policy responses implemented in the next decade. It also then provides a framework for forecasting results of these policies on sectors and investment returns. Investors committed to net zero will have to actively restructure their portfolios away from the high emissions sectors identified in this report and into low emissions sectors. Retail investors can then position their investments to benefit from the likely flow from high emissions to lower emission sectors.

In 2020, the Australasian Centre for Corporate Responsibility (ACCR) recorded 19 ESG-related shareholder resolutions lodged with ASX200 companies. Seven of the resolutions targeted governance changes, including the right to lodge non-binding shareholder resolutions, while six sought to drive company responses to climate change. Two resolutions focused on cultural heritage, three relating to lobbying and one on world heritage protection.

Overall, ESG-related resolutions in 2020 received an average support of 18.03% from shareholders. This is higher than in 2019, which saw 32 ESG resolutions put forward and an average support of 10.07%. However, climate change-related resolutions lodged with Santos, Woodside and Rio Tinto which received support greater than 35% meaning that, in some cases, a majority of investors want these companies to address climate issues and risks.

In 2020, there was also a number of resolutions were lodged and then withdrawn after the companies agreed to implement the principles of the resolution. For instance, a resolution on climate-related lobbying by Rio Tinto was withdrawn after the company agreed to implement a range of initiatives proposed in the resolution. This is significant as it shows that companies can be pushed to act on ESG issues by the lodgement of resolutions even if the likely percentage of shareholders that support the resolution is low.

While 2020 had a lower number of resolutions, our view is that the long-term trend will be a growing number of increasingly sophisticated shareholder resolutions, and that these resolutions will lead to higher engagement by companies on the resolution issues. Company strategies, particularly on climate change and community issues, will be highly impacted by these shareholder resolutions, so involvement from all investors is important.

Retail investors have a role to play in ESG shareholder resolutions as voters, but they face two challenges: accessing relevant ESG information on shareholder resolutions that they are able to vote on, and the lack of ongoing resources for monitoring and evaluating actions that results from shareholder resolutions. Retail investors can become informed on ESG resolutions through organisation such as the Australian Shareholder Association (ASA) and by accessing relevant research at the Altiorem sustainable investment library. Information on how companies are performing on ESG issues after a shareholder resolution can be accessed through the ACCR.

Retail investors can also review progress made in other countries on ESG-related engagement to get an idea of how it might affect Australian companies. The Mapping of global responsible investment best practices report by Inflection Point Capital Management and Norwegian Ministry of Finance is also available on Altiorem. The report sets out the diverse range of governance and organizational arrangements used by institutional investors, as well as different approaches and tools, to take their responsible investment and ESG agenda forward. Using these resources, retail investors can understand the direction ESG-related shareholder resolutions may take over time.

Apart from the headline increase in responsibly managed assets, another fascinating signal from the Responsible Investment Association of Australasia 2020 Benchmarking Report was the high growth in impact investments in Australia. From 2019 to 2020, investments that aimed at addressing social or environmental issues while also creating positive financial returns for investors grew 44% to $19.9 billion with $195 million invested in public equities. This small base but high growth is mirrored by the Global Impact Investment Network’s 2020 Annual Impact Investor Survey, which noted that impact investing was increasing and that $41 billion was held in public equities.

Key impact investments include green bonds, community finance products, and property or infrastructure funds that are largely separate from the public equity markets. Some publicly-listed companies have begun to discuss their business models in terms of impact such as the amount of carbon dioxide emissions avoided by installing renewable energy. However, there is limited impact investment available to public equity investors in Australia.

In 2021, we see the continued emergence of public listed investment that generate impact, driven by an increasing appetite from institutional and retail investors to pursue opportunities in the listed market. In turn, these investors offer impact-focused companies greater opportunity to source capital. Investors are pushing back on the view that impact cannot exist in the listed markets as the pursuit of profit would somehow water down the conviction to generate impact.

But as this trend evolves, the definition of impact need to be clear. In our view, this purpose can be maintained through a focus on three core principles: intention, additionality and reporting. The listed company should have clear intention to focus on its core purpose of making a positive impact while being additional in that it brings new capital to the impact theme rather than simply competing against and crowding out existing organisations. Finally, there is regular measuring and reporting of its social and environmental impact on a par with its financial reporting.

A tool for assessing the impact credentials of a company is the B Corp rating system. The non-profit B Labs Australia applies a rigorous assessment of the social and environmental credentials of companies and assigns a numerical score, allowing the ranking of alternatives. To date there have been only a handful of publicly listed B Corps with five in the Australian market; Australian Ethical Investment, Arowana, Kelly and Partners, Synlait Milk and Kathmandu. The evolution of the listed impact market may see that change over time and retail investors can use tools like B Corp reporting to understand the impact of the growing number of publicly listed B Corps.

As the ESG sector continues to grow in size, a range of new considerations will be included in stock selection for retail investors. Net zero portfolio commitments mean that superannuation funds will be rotating their investments out of high emission companies into lower emissions companies. Shareholder resolutions will increasingly be used to drive engagement in key ESG issues between companies and investors with ESG concerns. Impact investing is also arriving in the public equity markets. Retail investors will be impacted by the range of ESG investment strategies being developed, particularly investing in companies that will benefit from the net zero portfolio commitments, but there are greater responsibilities for voting on the rising number of ESG resolutions. Impact investing in the public markets provides another potential avenue for enabling retail investor’s to generated impact with their investments. It is an exciting time in the public markets as retail investors.

Sebastian Vanderzeil is a ESG and impact consultant with Strabo Rivers and supports sustainable investment advisor, Cornerstone Capital Group, as a member of their Global Advisory Council.

Ashleigh Steeles works in the financial advice industry and is passionate about using ethical and socially responsible investments to make a positive change for clients and society

Phil Vernon is the former Managing Director/CEO of Australian Ethical Investment and current Director of Beyond Zero Emissions and the Environmental Defenders Office.

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