This is a speech recently given by Peter Lambert, chief executive of Local Government Super, to delegates of the Australian Institute of Superannuation Trustees’ Australian Superannuation Investment conference on the merits of divesting from companies making unethical products or whose actions damaged the environment.
It was in 2000 that Local Government Super (LGS) decided it would not own shares in tobacco, but rather than restrict the mandates of our investment managers, we decided to exit these stocks through a long/short overlay.
One of the prime reasons we used a long/short overlay was to measure the impact of negatively screening out selected industries. I suspect that at the time we were considered “one of those pixies in the garden”. Perhaps even more so when a couple of years later we added gambling, uranium mining, armaments and old-growth logging to our list of excluded industries.
Why did we ban them?
We believed that these were industries that are detrimental to the society we lived in and we wanted to take a leadership position – I will return to this shortly – but fundamentally we felt that these industries would face increasing regulatory sanctions and the probability of an uncertain long-term future.
In fact, LGS had already embraced the concept of ESG investing long before the name was ever coined. That is, taking into consideration the long-term environmental, social and governance risks in our investment decision-making framework.
Admittedly, this was a fairly crude approach; it was predominately industry specific.
With regard to individual stocks themselves, we were fairly limited and Nathan Fabian [chief executive of the Investor Group on Climate Change Australia/New Zealand, who appeared on stage with Tom Lambert] will recall in his previous life at Regnan how I came to him to see how we could obtain quality research on Australian stocks that ranked poorly on these ESG factors and those who ranked well, so we could incorporate the same long/short methodology into our overlay for specific stocks.
International shares were a challenge: the research is there but the universe is much larger and the holdings widely dispersed. So, one of the briefs when we employed our head of sustainability was to extend this long/short overlay to our international share portfolio, without it becoming an overly elaborate, costly, time-consuming exercise.
Clearly, fixed income presented an even bigger challenge. However we have managed to incorporate an ESG overlay into our sovereign bonds through a specific mandate, which ranked high government debt levels as an ESG risk. The performance of this mandate is measured against an unconstrained benchmark.
So, while our journey is not complete, we feel we have done most of the heavy lifting. Of course the real test is with the performance numbers. I am pleased to say that since its inception in 2000, the Australian share overlay has returned 0.11 per cent per annum and the international share overlay 0.04 per cent per annum. If we had the international share overlay in place for the same period, I dare say the results would have been broadly similar.
The sovereign bond portfolio has not performed as well, in fact it is eight basis points below the benchmark, but remember this portfolio has only been in operation for less than two years and really performs well during tough credit conditions, so we obviously would have loved to have had it in operation prior to the global financial crisis.
I know these results are modest, but they are real, so let’s not hide behind the argument that ESG investing will harm your returns.
Leading active ownership
I now want to touch on the leadership position that I mentioned earlier. I am genuinely surprised that large super funds don’t feel they have some responsibility in this area. Do we really see ourselves as faceless financial institutions whose sole goal is to make money? Members expect us to have a pulse and will, over time, call us to account.
Let there be no mistake: non-governmental organisation’s will be increasingly targeting superannuation funds. Their members are our members. In fact, we received a number of letters from members around the time that Gunns were looking to expand their operations into the pristine Tasmanian wilderness. Clearly theses members were being primed by organisations such as the World Wildlife Fund, but we were able to respond positively, showing how we had taken the stance to divest all our shares in Gunns. We turned a potential negative into a positive.
Being an active asset owner does not necessarily mean divestment. We are all too aware of the terrible situation in Bangladesh, where over 1000 textile workers were killed in a factory fire and the conditions that led to it. How many superannuation funds have even written to the major Australian retailers asking about their supply chain management? I can assure you if a number of funds did this they would sit up and take notice.
How would you respond if one of your members asked you what you have been doing? You tell them your responsibility is simply to invest their money to make the best return possible. Now watch Twitter go into overdrive as your brand is trashed.
Ultimately, ESG investing is for the true believers. That is, you accept that certain risks, whether they be environmental, social or governance, can affect the value of investments. These risks will more than likely play out over the longer term, but after all, are we not long-term investors of our member’s money?
The MySuper disclosure requirements are not the issue here. Conceptually, MySuper is for the disengaged member. Regardless of MySuper, funds should be disclosing their holdings; we are not Swiss Banks. I see nothing wrong with a superannuation fund being required to have a good argument for why it invests, right down to the stock level, if need be.
There is no evidence to support the position that taking into account ESG considerations as part of your investment framework harms investment performance. In fact, given that the evidence is the opposite, I believe that you risk breaching your fiduciary duty by not doing something about it.
We live in a world where we are coming under increasing scrutiny. The rationale of where you draw the line is really nothing more than an excuse to do nothing. But by doing nothing, you are leaving yourself vulnerable to irreparable brand risk due to your passive endorsement of an unacceptable practice. This to me is poor risk management.