Robbie Urquhart: Responsible investing isnt black and white

OPINION:

Ethical and responsible investment has rightly been a hot topic lately. Many have weighed in on how companies measure up in terms of their environmental, social and governance (ESG) commitments, often based on ratings or slogans.

For investors, it can be confusing and hard to work out what it all really means. What should or shouldn’t you consider when determining what makes a “good” ESG investment?

As a business responsible for investing $14 billion of Kiwis’ funds,Fisher Funds has to grapple with these issues every day.

If there’s one thing that’s clear, it’s that when it comes to responsible investing, catchy slogans or simple ESG rating schemes often don’t tell the whole story. The answer is often not black and white.

Take the recent announcement that petrochemical company Ineos would sponsor the All Blacks as an example. This sparked controversy.

“Why associate one of New Zealand’s strongest brands with an industry that makes climate change worse?” cried critics.

Because Ineos is innovative and committed to a future with zero carbon emissions, replied advocates. (Not to mention the wide range of commercial benefits their sponsorship offers.)

This debate neatly summarises the challenge of including ESG factors in investment decisions. As active investors, we believe it is important to evaluate the grey area between the black and white ESG judgments.

Ignore or exclude?

Many investment companies either ignore ESG factors or exclude whole industries. Let’s take a step back and look at what ESG means.

“Environmental” is about how companies affect the environment. Investors may be concerned about industries that contribute to climate change, such as the oil and gas industry.

“Social” is about how we treat people and animals. Investors may be concerned about companies exploiting workers or testing their products on animals.

And “governance” is about how a company behaves. Investors may be concerned about a company’s policies, how it handles its responsibilities, makes decisions, or the wayit treats employees.

Investors broadly agree on what the three letters stand for, but they don’t agree on how to assess ESG factors when they’re investing.

At one end of the scale, investors have no concerns about ESG investments. Anything goes! At the other end, investors apply broad exclusions againstinvesting in entire industries.

It pays to engage

Active investors can look beyond exclusions and engage with companies.

For us, ESG has been central to all of our investment decisions for many years. Our ESG committee excludes certain industries and companies from our portfolios. For example, we exclude weapons manufacturers — including firms producing landmines, chemical and nuclear weapons, and assault rifles.

But we’re careful about what we exclude. Exclusion is a blunt instrument. It classes a company or industry as either good or bad. Exclusion ignores the challenge of evaluating the vast grey area in between these extremes.

When a controversy arises, we research, discuss, and weigh up the good and the bada company does.

Our active investment approach enables us to do this. As active investors we can engage with the company. That means through our research process we get to know the people running the companies in which we invest. We pick up the phone and talk to management or the board to understand their position and discuss issues when they arise. We can also exert our influence by voting as shareholders.

As a last resort, we can sell our investment in a company.

In contrast, passive investment managers are often not able to engage with companies.

Passive investors mechanically link their investments to a benchmark index. They have to invest in a broad range of companies regardless of ESG implications. If they do screen investments for ESG factors, they usually apply blunt exclusions. There is no room in this approach to deal with the real-world challenges that companies face — the “grey” of the real world if you like.

A nudge to change

Companies are often assessed for ESG purposes based on data and ESG scores that investment managers get from specialist ESG assessors. This sounds good. But different sources and interpretations of this data by the assessors can result in varying classifications of companies depending on the investment managers.

There’s definitely a place for ESG data and we incorporate it into our responsible investing framework. But we don’t rely on these ESG scores alone when making our decisions and neither should you. We acknowledge the genuine complexity that exists when considering ESG issues.

As an example, we exclude tobacco manufacturers from our portfolios.

Some ESG tools that screen for tobacco highlight Seven & i, a chain of Japanese convenience stores, because it sells tobacco products. But tobacco only makes up a small part of Seven & i sales, meaning it gets far more revenue from other products. On balance, we believe this outweighs the negative from tobacco sales.

Seven & i is not on our exclusion list because it makes a positive contribution to society.

I’m sure many people in lockdown have appreciated the service provided by supermarkets and convenience stores like Seven & i in the past few weeks!

So when it comes to ESG decisions, things are rarely simple. But we think an approach like ours is more sensible than relying on exclusions or ESG scores alone.

Through engagement, we’re more likely to be able to nudge companies in a positive direction.

Regardless, it’s great news that ESG, with all its complexity, is being discussed and debated more. Responsible investment managers will always differ in their approach to ethical investing but our goals are almost always the same. This bodes well for our future.

– Robbie Urquhart is senior portfolio manager at Fisher Funds.

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