Saturn Advice’s Approach to Responsible Investing

Saturn Advice’s Approach to Responsible Investing

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By Peter Dine 23rd June 2020

Responsible investing has historically been the domain of groups or individuals with very strong ethical views governing what they will (or more likely will not) invest in. Socially Responsible Investing and Ethical Investing are sometimes terms used to describe Responsible Investing albeit the drivers for the latter are more to do with good commercial practices and outcomes than purely ethics. Historically, the guiding belief was there is a price to pay for Responsible Investing, being lower investment returns. The world has changed!

Responsible Investing can enhance returns

Responsible Investing is fast becoming mainstream with thought leadership coming from high profile institutional investors such as the NZ Super Fund.  In a white paper published back in November 2015 the NZ Super Fund stated;

“It is a well-established corporate belief that good management of environmental (E), social (S) and governance (G) factors – including governance, employee relations, safety, and environmental risks – is material to the long-term successful performance of any business”, and “overall, there is strong evidence that companies that do well on ESG metrics tend to perform better[1].”

ESG is now an acronym widely used in investment circles to describe the three key elements for Responsible Investing. It is however a complex, sometimes controversial and still very much evolving area. Research and ratings for measuring how well companies (and funds) perform through the ESG lens continue to be refined and used to assist professional investors and advisers in their investment decision making.

If you’re sceptical as to whether good ESG practices make a positive difference to financial performance, consider what happens when poor ESG practices manifest themselves. BP’s Deepwater Horizon oil spill in the Gulf of Mexico back in 2010 saw an estimated 4.9 million barrels of oil discharged into the ocean. According to an article from the Guardian newspaper in 2018[2], BP ended up paying $65b USD in compensation. In 2015 Volkswagen admitted to rigging millions of diesel cars around the world to cheat vehicle emission tests. According to CNN[3], the scandal cost Volkswagen $30bn USD. And closer to home, in Australia the Commonwealth Bank was fined $700m AUD in 2018 for breaches of anti-money laundering regulations. If that wasn’t bad enough, according to Australia’s Financial Review[4] CBA racked up an additional $2bn in costs and compensation associated with misconduct uncovered by the 2018 Royal Commission into banking, superannuation and the financial services industry. All 3 examples not only tarnished the reputation of these high profile companies, but resulted in significant financial hits.

Two main approaches to Responsible Investing

Broadly speaking, there are two approaches to incorporating ESG into investment decision making. The first is to adopt a negative screen whereby companies or even entire industries are excluded. We saw this happen in 2016 when a number of KiwiSaver Fund providers started excluding controversial weapons and tobacco investments from their funds. The government doubled down on this by announcing on 1 March 2020 it would require KiwiSaver default funds to exclude investment in fossil fuels.

A challenge with negative screening is where to draw the line. Some industries or companies maybe clear cut to exclude, whereas for many others it is a far more difficult and subjective assessment.  Take the manufacture of electric vehicles. On the face of it, EVs get a very big environment tick and wouldn’t be a candidate for negative screening. That is until you consider their large battery packs are made of lithium, nickel, cadmium and other metals needing to be mined from the earth. Furthermore, what happens to EV batteries when they are past their useful life? Also, whilst EVs are recharged by electricity, what if the source of the electricity is a coal fired power station or a nuclear power plant? We’re not suggesting for a minute companies manufacturing EVs should be excluded from investment on ESG grounds, but we are saying negative screening decisions can be both complex and subjective.

The second approach involves active engagement and ownership of companies rather than avoidance. This includes engaging with companies to improve their ESG practices, and being an active owner through exercising voting rights. Unlike negative screening which reduces the universe of investment opportunities, an active approach allows investors to benefit from the upside potential when companies improve their ESG practices.

In practice both negative screening and active engagement can be used simultaneously in Responsible Investing.

Saturn Advice’s Approach

At Saturn Advice, we believe there is clear evidence companies who embed environmental, social and governance (ESG) considerations into their decision making are likely to achieve superior long term financial performance compared with companies that don’t. We also believe given the choice, investors would prefer to invest in companies with good ESG practices on the basis they are likely to benefit through better long term returns.

From the growing interest in ESG investing has emerged a range of funds marketed as Socially Responsible investments. However, we think there is a risk of “green washing” where funds marketed as having good ESG credentials in reality offer little difference to funds that aren’t labelled as such. In our view, ESG should simply be embedded into the investment decision making process and not be a separate solution.

Saturn Advice has taken the following practical steps to embed ESG into its investment decision making process;

  1. Any fund manager added to our approved asset list must have documented ESG policies or principles;
  2. When meeting with managers, we will ask for examples of how they have incorporated ESG into their decision making process;
  3. Our preference is for managers to be signatories to the United Nations Principles for Responsible Investment and support the UN Climate-related disclosure;
  4. We will monitor ESG scores (where available) for funds on our approved asset list using the Sustainalytics[5] ESG frame-work;
  5. ESG scores will be discussed with fund managers and considered in decisions to retain or replace funds on Saturn’s approved asset list

 

Responsible Investing is an evolving area and Saturn Advice is committed to further developing its ESG decision making frame-work to provide clients with superior long term risk adjusted returns.

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[1] How we invest. White Paper. Why we believe responsible investing pays off. Anne-Maree O’Connor, David Rae and Rishab Sethi, NZ Super Fund November 2015
[2] https://www.theguardian.com/business/2018/jan/16/bps-deepwater-horizon-bill-tops-65bn
[3] https://money.cnn.com/2017/09/29/investing/volkswagen-diesel-cost-30-billion/index.html
[4] https://www.afr.com/companies/financial-services/cba-makes-714m-provision-for-compensation-20190513-p51mny
[5] Sustainalytics is a global leader in ESG and Corporate Governance research and ratings