Responsible investing started in the 1960s, when investors started to exclude stocks or entire industries from their portfolios based on business activities. More recently, responsible investing has also involved finding and encouraging companies that have positive ESG attributes!
This week, we talked to Rebecca Lindegger from Pathfinder about responsible investing. Rebecca is an environmental scientist who assesses ESG risks and opportunities in potential investments, as well as engages with companies and collaborates with other investors to encourage better ESG practices.
What is ESG investing?
ESG stands for Environmental, Social, and Governance. These factors are part of our investment decision process (in addition to traditional financial measures). Identifying ESG risks and opportunities provides an additional layer of risk management on top of conventional financial risks and opportunities.
There are a huge range of ESG factors that vary from business to business. A few examples include the impacts of:
- Climate change
- Greenhouse gas (GHG) emissions
- Water scarcity and resource management
- Negative environmental impact on local communities
- Workplace health and safety
- Product safety
- Issues in the supply chain, such as human rights of workers
- Employee diversity
- Animal welfare
- Bribery and corruption
- Board diversity
- Executive pay
- Ownership structure
- Organising a business to avoid paying tax in jurisdictions where revenue is earned
How do you measure ESG?
To be meaningful, each ESG factor must be consistently measured over time. For example, Health and Safety metrics could include work-related accidents, hours of training, or staff turnover. Greenhouse gases could be reported by the quantity and frequency of emissions. Think of it as a framework for analysing company performance against non-financial metrics (although these metrics can have a very real financial impact on the business).
How do you decide which companies to include or exclude in the Pathfinder funds?
How seriously an investor takes responsible investment will vary and depend on where they ‘draw the line’. There are lots of ‘right’ answers and no one-size-fits-all solution.
At Pathfinder, we avoid investments that have a significant negative impact on society and the environment—we believe that even when there is good potential for short-term returns, they’ll make poor long-term investments! For example, we avoid companies associated with adult entertainment, thermal coal, controversial weapons, gambling, and tobacco. We also exclude companies with a high level of current controversy in their activities. The next step for us is to focus investment into companies with high ESG practices that are in countries and industries where we want to invest.
Once we’ve invested in a company, we believe it’s important to engage. This can be using our voting power as a shareholder, or collaborating with other investors to encourage companies to manage ESG and non-financial risks better.
Why should we care about ESG?
Incorporating ESG factors allows each of us to align our personal values with our investments. Research also shows that using an ESG framework can improve investment outcomes (meaning better returns and/or lower risk) over long investment horizons. For example, one study showed that if you invested in higher scoring ESG companies in the US, over a 10 year period, you had slightly higher returns and avoided 90% of bankruptcies.
Can you still make money from socially responsible funds?
Absolutely! The idea that investing responsibly or ethically means you have to accept lower returns is an outdated myth. Companies with good ESG metrics tend to exhibit lower risk in terms of price volatility, earnings volatility, and even bankruptcy risk.
What are the current trends or areas of growth related to responsible investing?
- The transition to a low-carbon economy—this impacts all companies, but particularly the suppliers and heavy users of fossil fuels
- Managing water resources—access to clean water is a critical issue around the globe. Cities like Cape Town are under huge water stress, which can lead to a humanitarian as well as an environmental issue
- Is sugar becoming the new tobacco?
- Corporate governance—the Facebook scandal illustrated how companies can expose themselves to a range of financial, regulatory, legal, and reputation risks by not managing their corporate governance systems properly
What is the Pathfinder Global Responsibility Fund and the Pathfinder Global Water Fund?
The Global Responsibility Fund invests in around 250 global stocks. Analysing environmental, social, and governance metrics for each company is a key part of the investment process.
The Global Water Fund invests in companies trying to solve the global water crisis. These tend to be industrial companies, utilities, and tech companies. The fund will not invest in bottled water, and has between 50 to 100 stocks at any time.
The Global Responsibility Fund and Global Water Fund have both been designated as Certified Responsible Investments by the RIAA (Responsible Investment Association Australasia).
Society’s conscience and awareness have changed—what was once seen as acceptable and appropriate may now be seen as unethical behaviour, and a potential financial risk. Society is now more aware about the wider impact that our choices have, as consumers and as investors.