Hartnett says that Australian funds managers should observe the way Australian chief executives navigate their businesses through a marketplace in which carbon is more expensive, since this is an indication of management quality. “Today’s CEOs didn’t read about these situations in text books at university.” Other cases of poor extra-financial performance include instances where some Australian manufacturers have exploited cheap labour in Asian countries, resulting in a “below par” standard of supply chain management.

Also, ‘product liability’ problems, such as the cancer-inducing asbestos products from James Hardie, can arise and affect companies’ sharemarket performance. A notable example of this is the subprime mortgage mess, which Innovest identified in 2006 as a ‘social risk’ problem when it became evident how unlikely it would be that subprime mortgage borrowers would repay loans issued to them. “We might applaud a bank for installing energy-efficient lighting, but a bank’s real risk is who they lend to and how they do it,” Hartnett says.

Certain shades of green

While sustainability is a key factor in analysing a company’s extra-financial risk, there is “no hard-and-fast law of what constitutes sustainability”, SIRIS’ Bytheway says. “It depends on your terms of reference. And criteria change. “Could you put BHP Billiton in a sustainability portfolio?

If you look at how they manage risks and opportunities, it’s plausible.” SIRIS included the miner in a sustainability-focused structured product that it recently built for nabCapital – the Sustainability Note – for release into the sub-institutional market, whose investors include universities and high net-worth individuals.

The static portfolio of 20 companies also holds major banks such as ANZ, Westpac and National Australia Bank, property group Lend Lease and diversified business group Wesfarmers. Presenting its view of a sustainable investment, the manager asked SIRIS to build the portfolio from companies among the top 50 in the ASX200 that did not derive more than 5 per cent of their revenue from industries such as tobacco, firearms and alcohol.

International equities boutique Five Oceans Asset Management (Five Oceans AM) takes a different stance. The manager looks for emerging themes from within the business, social, political and environmental spheres, and integrates this with a value-based investment strategy that allows for contrarian cross-checks.

Analysis of ESG data is one input into the manager’s investment process. For some of this information, it draws on ratings of companies supplied by Innovest. “We’re looking for directional change in the area of ESG,” Ross Youngman, Five Oceans AM chief executive officer, says. “Huge environmental blow-ups have cost companies.” If a company it assesses is exposed to an extra-financial risk and is not combating it, or has not formulated a strategy to counteract it, it will probably be excluded. “If a company is not going to improve, that is risk. We might pass on that company,” Youngman says.