Op­er­at­ing to an eth­i­cal mantra can boost the bot­tom line

The Weekend Australian - Review - - Investments - Karen Frith

SUS­TAIN­ABIL­ITY is no longer con­sid­ered an eth­i­cal or moral is­sue in in­vest­ment de­ci­sion- mak­ing, but has helped pro­vide su­pe­rior fi­nan­cial re­turns and acted as a flag for in­vestors to avoid high- risk com­pa­nies, fi­nan­cial mar­ket an­a­lysts say.

En­vi­ron­men­tal, so­cial and gov­er­nance is­sues ( ESG) are now be­com­ing a key fac­tor in cap­i­tal mar­ket in­vest­ment de­ci­sions, and in­creas­ingly money man­agers are seek­ing out com­pa­nies with a high ESG rat­ing — those that have a sound en­vi­ron­men­tal track record, that take care of their staff, re­late well to the com­mu­nity around them, and have a well- run ship with good lead­ers at the helm.

Over the medium to long term, sus­tain­abil­ity will be a key driver of in­vest­ment re­turns and risk,’’ saya Andrew Gray, head of ESG re­search at Gold­man Sachs JBWere.

ESG is not just a moral is­sue, it’s about the ef­fect on re­turns. We have found clear links to value in ESG which means it is com­pletely rel­e­vant to in­vestors,’’ Gray says.

Shane Oliver, chief econ­o­mist at AMP Cap­i­tal In­vestors, says there is a grow­ing in­ter­est in sus­tain­able in­vest­ing and that while it was con­sid­ered a fringe’ style of in­vest­ment a decade ago, it is now be­com­ing more prom­i­nent. The per­cep­tion years ago was that it was some­thing for gree­nies, but there is clear ev­i­dence that it en­hances re­turns on share­mar­kets and it is start­ing to be­come more main­stream,’’ he says.

In a re­port re­leased last month, Oliver’s col­league, se­nior an­a­lyst Alan Woods, says that en­vi­ron­men­tal and so­cial is­sues are likely to be among the most crit­i­cal fac­tors shap­ing gov­ern­ment pol­icy and cor­po­rate strat­egy within the next 10 years. ESG is­sues are now a nec­es­sary part of in­vest­ment de­ci­sions, Woods says.

A sign that sus­tain­abil­ity has be­come a fo­cus for Aus­tralia’s in­sti­tu­tional in­vest­ment com­mu­nity is the strong cor­po­rate par­tic­i­pa­tion in the UN’s PRI ini­tia­tive — the Prin­ci­ples for Re­spon­si­ble In­vest­ment. The PRI is a vol­un­tary ini­tia­tive where sig­na­to­ries com­mit to give ap­pro­pri­ate con­sid­er­a­tion to ESG is­sues and in­cor­po­rate them into main­stream in­vest­ment de­ci­sion- mak­ing.

Sig­na­to­ries ( to the ini­tia­tive) are work­ing through how to im­ple­ment the prin­ci­ples and in­te­grate them into their in­vest­ment de­ci­sions, so it ( ESG) is be­ing seen as some­thing that pro­vides in­vest­ment value,’’ says Elaine Prior di­rec­tor and se­nior an­a­lyst at Citi In­vest­ment Re­search. How­ever, Prior says while ESG is­sues are only now be­com­ing a larger fo­cus for some in­vestors and an­a­lysts, she be­lieves ESG has been prac­tised for some time now.

She says that over time, ESG will sim­ply be a nor­mal part of what in­vestors take into ac­count when as­sess­ing com­pa­nies — it shouldn’t be seen as a short- term, sep­a­rate is­sue.

With the grow­ing aware­ness of the im­por­tance of sus­tain­abil­ity or ESG is­sues in in­vest­ment cir­cles, there has been lit­tle work to quan­tify what it may mean in dol­lar terms to Aus­tralia’s pub­licly- listed com­pa­nies.

Gold­man Sachs JB Were is lead­ing this work in Aus­tralia and ex­pects to es­tab­lish the coun­try’s first sus­tain­abil­ity in­dex’ of top per­form­ing Aus­tralian com­pa­nies across all ar­eas of ESG within the next six months. The in­dex will be the first of its kind, rat­ing com­pa­nies across all ar­eas of ESG and not just on sin­gle ar­eas such as busi­ness sec­tors or on the en­vi­ron­ment.

In his work so far to es­tab­lish a rat­ings sys­tem for the sus­tain­abil­ity in­dex, Gray says he has found some sig­nif­i­cant re­la­tion­ships to price per­for­mance of stocks which rated highly in the area of cor­po­rate gov­er­nance.

Us­ing seven years of data from part­ner CGI So­lu­tions, Gray says com­pa­nies that rate highly in the gov­er­nance area are out­per­form­ing other ASX200 com­pa­nies.

He says where com­pa­nies rate well on re­mu­ner­a­tion they re­turned an av­er­age of 47 per cent more than the mar­ket. Where com­pa­nies rate well on au­dit pro­cesses the re­turn was 37 per cent above mar­ket and where they rate well on board skills they re­turned an av­er­age of 19 mar­ket.

Based on th­ese re­sults, we con­clude that cor­po­rate gov­er­nance anal­y­sis can help im­prove in­vest­ment re­turns. Based on our re­search we think gov­er­nance is highly valid.’’ He says in the area of hu­man cap­i­tal man­age­ment, a part of the so­cial as­pect of ESG, work­place health and safety is use­ful as a risk screen to help screen out un­der­per­form­ing stocks.

Ac­cord­ing to his re­search in this area, based on data from Reg­nan, stocks with poor health and safety records un­der­per­formed the ASX200 by 30 per cent dur­ing the past four years since data was avail­able.

Sound rat­ings for com­pa­nies in the area of work­place health and safety can act as a good risk screen for un­der­per­form­ing stocks, it doesn’t pick out­per­for­mance but we be­lieve it is a bench­mark you should con­sider,’’ Gray says.

Gray says that with the im­mi­nent manda­tory emis­sions trad­ing leg­is­la­tion due to be in place in Aus­tralia by 2010, com­pa­nies with heavy car­bon emis­sions could face costs of up to one- third of an­nual profit.

His re­search shows that un­der a new car­bon emis­sions trad­ing scheme, BlueScope Steel could be faced with costs of around 34 per cent of its earn­ings be­fore in­ter­est and tax, de­pre­ci­a­tion and amor­ti­sa­tion ( EBITDA) — based on a car­bon price as­sump­tion of $ 20 per tonne and as­sum­ing no com­pen­sa­tion or dis­pen­sa­tions from gov­ern­ment.

Sim­i­larly, Ones­teel would face losses of 16 per cent of profit, Alu­mina Ltd 14 per cent and Qan­tas 11 per cent of profit.

This is all po­ten­tial risk,’’ says Gray. It can’t be fully costed un­til the de­tails of the ( Rudd Gov­ern­ment’s car­bon trad­ing) scheme are fully avail­able and the draft leg­is­la­tion is ex­pected in De­cem­ber.’’

Citi In­vest­ment Re­search on car­bon emis­sions trad­ing by Prior shows that the cost to emis­sions- in­ten­sive com­pa­nies could be be­tween 5 to 45 per cent of cur­rent mar­ket value in the ab­sence of any abate­ment so­lu­tions, al­though some costs may be passed on to cus­tomers. Her work is also based on a $ 20- a- tonne car­bon price.

Ac­cord­ing to Prior, 75 per cent of com­pa­nies in the ASX100 will have ex­po­sure to the car­bon is­sue and the com­pa­nies most ex­posed will be in the steel, alu­minium, pe­tro­leum, ce­ment, chem­i­cals and min­er­als pro­cess­ing in­dus­tries. En­ergy gen­er­a­tors also qual­i­fied, but should ben­e­fit from higher power price.

per cent above

Main­stream shift: Shane Oliver

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