Perpetual : Why ESG must be more than a box-ticking exercise

The market for responsible investments in Australia has soared in recent years and grew exponentially throughout 2021 as climate action and related policy changes kept ESG issues front of mind for investors. However, Portfolio Manager for the Perpetual Ethical SRI Fund, Nathan Hughes, says it is important to reiterate that a range of other factors including social performance and governance must also be considered when assessing a company's ESG status holistically.

According to an annual study from the Responsible Investment Association Australasia (RIAA) the market for responsible investments in Australia grew to $1.281 trillion in 2020 from $983 billion in 2019 and all indications are that the 2021 figure will show similar rapid growth. Indeed, the 2020 figures show responsible investment assets growing at 15 times the rate that overall Australian professionally managed investments have grown. This dramatic shift of capital is being fuelled by changing consumer expectations, strong financial performance and the rising materiality of different social and environmental issues.

While the specific allocation of capital to target environmental outcomes often grabs the headlines, ESG is a sector in transition, with developments taking place rapidly across countries, regions and markets. Nathan Hughes acknowledges that climate action and related policy changes remain front of mind for many investors but stresses that social performance and governance are also important metrics.

"The Perpetual Ethical SRI Fund has explicit ESG screens, however, ESG is not a simple box ticking exercise, and certainly not merely relevant to funds with a sustainable or ESG badge. Often the line between a pure ESG issue or an industry issue is blurry, if indeed there is a line at all. Thoughtful consideration of ESG issues is therefore simply a part of rigorous business analysis," he said.

With many companies pledging themselves to long-term ESG targets, substance is crucial. How achievable are these targets, and who is accountable?

"A robust assessment of materiality is crucial," says Hughes. "To that end, we engaged with several of our smaller company holdings over 2021, as they seek to build out their sustainability strategies with a focus on what is particularly material to them. The key question is how can they do better in areas where they can make a difference, whilst also improving financial outcomes for us as investors and unit holders?"

Perpetual has also had the opportunity to engage with larger corporates in one-on-one settings around topics such as decarbonisation plans for heavy emitters. This has been the subject of further research within the equities team for industries where near-term solutions are elusive.

"Major bank exposures to fossil fuel are another topical matter and, as a result, we have been eager to understand the rationale behind bank lending policies and the run-off of existing books," says Hughes. "Given the relatively immaterial size of these loans in the context of total group balance sheets, I can't help but wonder if the resilience to climate volatility of the bank's large residential mortgage portfolio isn't a bigger issue, and indeed this is the subject of an ongoing APRA review."

This will be amongst the many ESG issues Hughes will be watching closely over 2022.

Find out more aboutthe Perpetual Ethical SRI Fund.