Go deeper than ESG ratings for the real deal
What should the local industry make of the offshore backlash against ESG ratings?
Friday, December 2nd 2022, 6:00AM
by Andrea Malcolm
During the US midterm elections, ESG investing principles were slated by Republicans, for elevating “left wing” goals over the interests of businesses and employees, some states blustered about banning pensions from taking ESG into consideration although nothing has come of it, and according to the Washington Post CFOs are pushing back against proposed SEC climate change disclosure rules and companies have grappled with the ESG materiality as well as complexity, and lack of consistency among various rating systems.
Across the Atlantic the European Securities and Markets Authority (ESMA) has an enquiry underway into how ESG ratings work, and the European Commission is consulting on the ESG ratings market place in the European Union.
Pathfinder chief investment officer Paul Brownsey says ESG is one of the most misused terms in the investment industry.
Brownsey, co-founder of Pathfinder, an independent boutique fund manager with a strong focus on sustainable investing.
“A lot of people say ESG confers this responsible nature on your portfolios but it’s just a data set, self reported by the companies, which tells a story about policy such as they avoid slave labour in their supply chain.
“A company will have ticked yes or no on all these considerations and accumulated points that determine the ranking but ESG doesn’t tell you anything about the nature of the business of that company, what they do, whether they are really behaving in a sustainable manner.”
An example is British American Tobacco, which has an ESG score of 84/100 in the 2022 S&P Sustainability Yearbook 2022. Elsewhere BAT has ranked 6th out of 6000 companies, he says.
“ESG ratings don’t provide the full picture. Fund managers still have a burden of proof that there are benefits to sustainable investment. At the end of the day it also comes down to performance.” According to Morningstar’s KiwiSaver results for Q3, Pathfinder KiwiSaver provided the top returns over three years across its conservative, balanced and growth categories.
Healthy debate
Jo Kelly, CEO of Toitū Tahua: Centre for Sustainable Finance says what we see playing out in New Zealand, is a healthy debate about what is or isn't credible ESG performance rather than a backlash against good governance, or environmental and social factors being a core consideration in the context of financial performance.
“In some regions there is a vigorous ‘value vs. values’ debate about the nature of fiduciary duty: whether fund managers have a duty to pursue short-term profit versus long-term sustainability on behalf of investing clients. This debate can be a bit polarising but is certainly not uniform across all regions.”
She says advisers need to ask questions about how their investments, both wholesale and retail, are labelled and be able to assess the credibility of the claims being made about where their money is going.
“At a wholesale level, we also need more definitions so investors can have confidence that they're allocating to sustainable activities. This will come in time and in the meanwhile investors are working to develop their own capability and processes in this area.”
Kelly points to the latest ‘Responsible Investment Benchmark Report Aotearoa New Zealand 2022’ by the Responsible Investment Association Australasia (RIAA) which shows that RI grew to half the market in 2021, reaching $179 billion or 49% of the total $365 billion investment market, up from a 43% share in 2020.
Last year, responsible investment products certified by RIAA on average outperformed the market on a risk-adjusted basis – further evidence that a systematic approach to analysing ESG risks helps underpin stronger long-term performance.
At the launch of the RIAA benchmark report, RIAA CEO Simon O’Connor spoke of seeing a third wave of responsible investing coming through, defined by the question: ‘how do we deploy capital to achieve positive impacts?’, following on from the first wave (‘do no harm’) and second wave (integrated ESG risk).
Andrew Bascand, CEO of Harbour Asset Management says there’s no perfect ranking system when it comes to investing. Harbour Asset Management runs its own corporate behaviour rating system which questions companies on ESG behaviours, as well as buying in information services.
“We contrast what they all say, put it altogether and come up with what I think is a sensible, broad view of companies that are shooting the lights out on RI, ones that are going well, those that we want to engage with, others we want to lift off the bottom and ones that are hopeless - and there’s not a lot in the hopeless category.
“But for advisers it’s tricky because some fund managers basically just do exclusions. However we are finding that consultants to advisers, the likes of Morningstar, My Fiduciary and ResearchIP, are beginning to lift their responsibilities here in New Zealand and overseeing all that is the legal structure; the Financial Markets Conduct Act which takes most aspects of the Fair Trading Act - that what you’re selling is true to the label. So I have a lot of faith in the New Zealand context that most of the people acting in this market are aware of their responsibilities.”
Dr Syrus Islam, an Impact and RI researcher at Auckland University of Technology, says financial advisers shouldn’t rely on ESG labels but do their own due diligence on the rating used to build ESG funds.
“Instead of primarily relying on ESG funds based on traditional [flawed] ESG ratings, financial advisors could do their own research to develop a better ESG portfolio. However, this could increase the cost for investors.”
He suggests that as an alternative, advisers could refer clients to impact funds but should, once again, be wary of labels without evidence.
| « NZ Super Fund moves from RI to sustainable finance | New guide climate change guide for directors » |
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