Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 391

Why ESG assessment must now consider active ownership

In 2020, as COVID-19 caused markets to whipsaw in response to economic recovery, vaccine and immunity hopes, the job of analysts assessing long-term asset value became far more complex and fast-moving.

The accelerated rate of change brought on by COVID also sped up critical investment decisions, highlighted the importance of Environmental, Social and Governance (ESG) considerations and expanded the discussion to include responsible investing and active ownership.

Social risk and active ownership questions

The year began with the enormous loss and hardship associated Australia’s bushfires. Summer brought another wave of COVID and more lockdowns. Not surprisingly, client interactions throughout 2020 touched on one, if not all, aspects of the ever-growing ESG issues. Questions on social risk, such as human welfare, supply chain and climate, as well as reputational risks, are now at the forefront of the investment discussion.

This has moved the ESG conversation beyond E, S and G factors and their application and integration into valuation models to what they need to be anchored to in order to drive change, which is active ownership.

The Principles for Responsible Investment (PRI) defines active ownership as the ‘use of the rights and position of ownership to influence the activities or behaviour of investee companies’, that is to say, the use of ESG engagement and proxy voting.

Regardless of how an investor chooses to own an asset, ownership is ultimately an undertaking to knowing a company’s business, and how the company is positioned for growth is essential to understanding its sustainability over the long term.

This was truer than ever in 2020 as businesses found ways to help their stakeholders deal with multidimensional crises such as COVID that overnight turned the world virtual, forcing individuals, families, communities, organisations, states and markets to interact in ways and on a scale never seen before.

The role of passive and active managers

Both passive (index) and active managers have an important role to play in realising the potential value that thoughtful engagement and proxy voting can create. While large passive managers have the size to influence voting on broad issues, their ability to effect nuanced engagements with companies is likely hindered simply because they own so many companies. Index investors generally have to buy all the companies in the relevant benchmark.

Typically, active managers are better positioned to look into businesses, industry operations and management. They use all the available information, including non-financial information (which is becoming increasingly mandated), to determine what will have a material impact on those businesses.

If they do not know the business well enough, they cannot tell the difference between one that is sustainable and socially responsible or not. Nor are they able to effectively challenge company management on how to deal with ESG risks and take advantage of ESG opportunities.

Active investors with deep research capabilities are able to perform 'materiality discovery' similar to price discovery and engage in a sustained way with investee companies to instigate change.

Research from Cambridge University shows that:

"ESG engagements generate cumulative size-adjusted abnormal return of +2.3% over the following year on the initial engagement. Cumulative abnormal returns are much higher for successful engagements (+7.1%)."

The research found no market reaction to unsuccessful engagements.

Investment organisations that manage sustainable investing through ESG integration, proxy voting and engagement are more likely to create sustainable value over the long term.

In addition, these active ownership attributes improve their ability to achieve their client’s objectives and meet their fiduciary responsibilities. We have yet to be convinced that offering products with ESG screens or overlays can do the same, perhaps it ticks a short-term box, but true long-term stewards should demand more.

ESG risk assessment a blunt tool

In our experience, investors want to know what longer-term, sustained improvement in the relevant ESG areas a company has made. Whilst we understand why transparency and measurement is important, we caution against an over reliance on narrow or blunt measurement tools, which cannot be expected to capture the nuance and range of the ESG risks faced by, and opportunities available to, companies.

The chaos in the marketplace in relation to assessing companies for ESG is well illustrated below. The world’s largest rating agencies, FTSE and MSCI, are virtually uncorrelated when it comes to ESG materiality. This creates an opportunity for managers such as MFS to engage with clients on how the criteria that we, ourselves, have been building can potentially drive long-term performance on their behalf.

 

ESG must include active ownership

Client alignment is at the heart of active ownership, so a critical part of the ESG discussion is to understand whether your investment manager is aligned with your views and how sustainability is factored into the investment process undertaken.

Active ownership will become a necessity and the norm for all managers, both active and passive. There is a chance that that passive owners, not passive managers, will get punished if they do not use their voting power to build more sustainable practices at companies.

At a time when we are facing more pressure and complexity than ever before, the managers who survive will be those that align with their clients' long-term needs and support the transition to a more sustainable society. This philosophy fuels our beliefs as an active manager.

 

Marian Poirier is Senior Managing Director, Australia for MFS Investment Management. The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice. No forecasts can be guaranteed. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.

 

RELATED ARTICLES

Amid vaccine hope and skepticism, testing is key

The role of financial markets when earnings are falling

Australia is heading for its third Omicron wave

banner

Most viewed in recent weeks

Are term deposits attractive right now?

If you’re like me, you may have put money into term deposits over the past year and it’s time to decide whether to roll them over or look elsewhere. Here are the pros and cons of cash versus other assets right now.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

How retiree spending plummets as we age

There's been little debate on how spending changes as people progress through retirement. Yet, it's a critical issue as it can have a significant impact on the level of savings required at the point of retirement.

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Latest Updates

Property

Financial pathways to buying a home require planning

In the six months of my battle with brain cancer, one part of financial markets has fascinated me, and it’s probably not what you think. What's led the pages of my reading is real estate, especially residential.

Meg on SMSFs: $3 million super tax coming whether we’re ready or not

A Senate Committee reported back last week with a majority recommendation to pass the $3 million super tax unaltered. It seems that the tax is coming, and this is what those affected should be doing now to prepare for it.

Economy

Household spending falls as higher costs bite

Shoppers are cutting back spending at supermarkets, gyms, and bakeries to cope with soaring insurance and education costs as household spending continues to slump. Renters especially are feeling the pinch.

Shares

Who gets the gold stars this bank reporting season?

The recent bank reporting season saw all the major banks report solid results, large share buybacks, and very low bad debts. Here's a look at the main themes from the results, and the winners and losers.

Shares

Small caps v large caps: Don’t be penny wise but pound foolish

What is the catalyst for smalls caps to start outperforming their larger counterparts? Cheap relative valuation is bullish though it isn't a catalyst, so what else could drive a long-awaited turnaround?

Financial planning

Estate planning made simple, Part II

'Putting your affairs in order' is a term that is commonly used when people are approaching the end of their life. It is not as easy as it sounds, though it should not overwhelming, or consume all of your spare time.

Financial planning

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.