While COVID-19 has dominated both news headlines and investors’ minds this year, hidden amidst the noise is that investment options in sustainable funds within the Australian retail marketplace are continuing to rise and show promising signs of performance during the volatility caused by the pandemic. This month’s edition of WD Life will explain what is meant by the term ‘sustainable investing’ as well as discussing the future of financial markets.
Environmental Impact on Global Financial Markets
Although we are yet to see any substantial impact on global financial markets as a result of environmental changes, it is not to say that this won’t become an issue within the future. According to a 2020 report by Morningstar, more than 60 central banks, including the RBA and the Bank of England, have warned that global GDP could fall 25% below the expected level by 2100 if the world neglects efforts to reduce global greenhouse gas emissions. Furthermore, it is reported that countries such as India and Nigeria could see their GDP fall as much as 90% during the same time. These alarming figures paint a grim picture for global economies and consequently, financial markets if we continue to neglect the impacts of environmental mistreatment. While this may seem a distant future, it important to be aware of how the environment could potentially impact you or your children’s financial future.
Sectors at Risk and Potential Opportunities
As investors begin to push for more environmentally friendly and sustainable investment options, several sectors may be adversely impacted of this change in perception. Guillaume Mascotto, head of ESG and investment stewardship with American Century Investments has identified the following sectors as most exposed to potential climate change risks: Oil and gas, mining, forestry, banks, power and utilities and transport. While many sectors may be negatively impacted, this could create opportunities for other sectors. Mascotto goes on to state that the following investment options may benefit from this change: power storage, biodiesel, wood-based construction, and biochemical applications, smart grids, renewables and digitalisation. While no investment sector is guaranteed to be better then another, it is important to stay knowledgeable and up to date with how sectors are performing and perceived.
The Future of ESG Investments
While still in its infant stage, the ESG market continues to grow within Australia at an exponential rate. At the end of the first half of 2020, assets invested in Australia domiciled sustainable investments was AUD 19.9 billion (excluding investments in fund of funds), an increase of 21% compared with 30 June 2019. Grant Kennaway, manager research with Morningstar further alluded to the potential benefits of ESG investing by stating “Investment options and assets in sustainable funds in the Australian retail marketplace continue to grow, with promising signs of performance during the volatility caused by the pandemic”. Morningstar also notes that many retail investors and superannuation funds within Australia are becoming increasingly aware of sustainability risks, suggesting this market will continue to flourish as more investing seek more sustainable investments over the long-term.
What is ESG Investing
ESG (Environmental, Social and Governance) investing refers to an investment class that is commonly referred to as “sustainable investing.” In short, ESG investments seek positive returns and long-term impact on society, environment and the performance of the business. ESG Funds are sustainable strategies that incorporate ESG criteria throughout the investment process. ESG are a subset of nonfinancial performance indicators which include sustainable, ethical and corporate governance issues to ensure accountability to best practice.
Environmental risks created by business activities have actual or potential ability to adversely impact land, water, air, ecosystems and human health. A business that is compliment with ESG would attempt to efficiently manage resources and prevent pollution resulting in a reduced emissions and climate impact as well as executing environmental reporting or disclosure. Positive outcomes derived from reducing a business’s environmental impact include avoiding or minimizing environmental liabilities, lowering costs and increasing profitability through energy and other efficiencies, Additionally, this may help reduce litigation and reputational risk.
The social criteria look at a business’s internal and external relationships. Social risks preclude to the impact that businesses may have on society and societal values. They are evaluated by how a business conducts itself such as promoting health and safety, encouraging labour-management relations, protecting human rights and creating sustainable product integrity. Creating a positive social environment in the workplace can lead to increased productivity and morale, reducing turnover and absenteeism as well as improving brand loyalty.
Governance risks is the concern of how a business is run and facilitated. It addresses areas such as corporate brand independence and diversity, corporate risk management and excessive executive compensation. Governance is crucial in aligning the interests of stakeholders and management as well as providing transparency and legitimacy to the business. Positive Governance can help increase board accountability and protect shareholders through accurate reporting and disclosing information. Finally, Governance can limit litigation risk as well as hostile financial decisions.
– Morningstar: Catching the sustainable investing bug