There is growing acceptance that we cannot continue to seek short-term financial returns at the expense of long-term sustainable outcomes.
Investors are inevitably exposed to the economic risks and opportunities of system-wide sustainability issues such as climate change, social inequity and global health crises.
Addressing these risks and opportunities requires rapid and significant change, ranging from how we power our homes and businesses, to how we travel, manufacture and consume goods, build infrastructure, support disadvantaged communities and so much more.
What role do investors play in this transition?
The United Nations-backed Principles for Responsible Investment (PRI) has been a leading investor-led proponent of responsible investment practices since 2006. Its current 5000-plus signatories, representing more than $120 trillion in assets under management, have committed to incorporate environmental, social and governance (ESG) factors into their investment processes.
They are held accountable to these commitments through publicly available annual reporting.
Investors can consider a broad range of ESG factors such as greenhouse gas emissions, diversity and inclusion, labour practices and board governance.
The PRI encourages investors to incorporate ESG factors not only in screening, but also in the ongoing monitoring of investments, to ensure accountability.
This has become increasingly part of mainstream investment practice globally. PRI data shows that in 2021, 72 per cent of signatory asset owners reported that when selecting actively managed listed equities managers, they required these managers to incorporate ESG factors in all investment analyses and decisions.
Over half of all reporting signatories also reported using at least one internationally recognised framework (e.g. the UN Sustainable Development Goals, the Paris Agreement, the UN Guiding Principles on Business and Human Rights, the OECD Guidelines for Multinational Enterprises or the EU taxonomy) to identify the sustainability outcomes of their activities. Among the remaining signatories that had not yet identified sustainability outcomes, half intended to do so in the future.
Investors are also increasingly engaging with investee companies and asserting their influence – as active stewards of investment monies – to achieve these outcomes.
PRI data indicates that 70 per cent of signatory investment managers have a stewardship policy. More than half of those policies included their main stewardship objectives, how they prioritised ESG factors and linked them to engagement issues and targets and how they approached collaboration and conflicts of interest.
The combined influence of institutional investors with a common objective is difficult to dismiss. Outgoing Qantas CEO Alan Joyce, for example, recently attributed the influence of superannuation investors to holding the national airline to account on its ESG commitments.
Initiatives like Climate Action 100+ (harnessing the collaborative efforts of global investors to hold the world’s largest corporate greenhouse gas emitters to account) and Advance (a PRI initiative where institutional investors work together to take action on human rights and social issues) are prominent examples of investors using their influence to engage with companies for positive outcomes.
Critics argue that considering sustainable outcomes in investment decisions means financial returns will suffer. However, a growing body of evidence suggests the opposite may be true: that companies with strong ESG performance tend to outperform their peers over the long term.
Companies with strong ESG practices are more likely to have resilient and sustainable business models, strong governance, minimise legal and reputational risks and maintain positive engagement with employees and customers, enhancing their long-term viability.
More fundamentally, systems-level risks will affect financial returns across diversified portfolios. Investors can better align their portfolios with the long-term interests of their clients by considering how their investment activities support a resilient and sustainable economy.
Australian investors are part of the global shift towards responsible investing. Australia is flanked by countries that are among the most vulnerable to climate change in the world.
A recent report by the Cross Dependency Initiative (XDI) also identified Victoria, New South Wales and Queensland as among the top 10 per cent of global jurisdictions most at risk from the physical impacts of climate change. Australian businesses face risks to long-term value preservation if they do not consider their exposures or contributions to environmental degradation, poor governance, inadequate consideration of human rights and economic inequality.
Regulatory changes have contributed to the uptake of responsible investing. Recent years have seen a trend towards better disclosure on ESG issues at the national and international levels, including through the Australian Government’s recent moves to introduce mandatory climate-risk disclosures by large businesses and financial institutions.
Changing client expectations are also a factor. Clients are increasingly concerned about social and environmental issues and expect their investments to be aligned with their expectations of how their monies should be invested, and how businesses should operate.
Challenges remain, such as the nascent nature of internationally recognised standards on sustainability reporting, short-term investment performance benchmarks and limitations in ESG data.
But there are also opportunities to accelerate change, including more collaboration between investors on engaging with companies and governments on sustainability issues, education and policy guidance for enhanced stewardship practices.
In short, responsible investment, supported by enabling policy, can help create the virtuous cycle of positive change that is needed for the global economy to transition to a more sustainable future.
Investors must actively consider the long-term economic impacts of their investments if we are to achieve a systems-wide transition to a more sustainable economy.