NZ joins sustainable investing drive

SHOT DOWN: Investments such as tobacco, alcohol, gambling and weapon manufacturing are off the list in the trend to sustainable investing. PHOTO/AP

Sustainable investing is rapidly evolving across the global financial industry and now represents $63.5 billion assets under management in New Zealand, according to the Responsible Investment Association Australasia (RIAA).

Traditionally a niche activity, it is now an opportunity for investors to express their concerns about issues such as resource sustainability and climate change, whilst earning a competitive financial return.

Historically, sustainable investing in equity markets took two main forms.

The first involved choosing a relatively small number of stocks that were considered desirable from an ethical or environmental point of view. This approach compromised the benefit of having a broadly diversified portfolio, and its international performance track record has, in general, been poor.

The second approach involves screening out from portfolios companies involved in activities such as tobacco, alcohol, gambling and weapon manufacturing. A criticism of this method is that while it reduces exposure to these activities, it does not place any weight on companies that are making a positive difference.

Sustainable investing has evolved to an approach that aims to incorporate environmental, social and governance (ESG) considerations as a core component of any firms' investment process.

In listed markets, these efforts have in part been enabled by major index providers, such as the MSCI and FTSE, developing and reporting ESG ratings for the very broad set of companies that they cover. This includes, for example, metrics on a company's greenhouse gas (GHG) emissions profiles, water usage, company board structures and composition, and human and labour rights records.

An effective focus on ESG considerations may help identify new opportunities for revenue, for example, "green" products and services, or cost reductions through better managing supply chains.

An investment process that incorporates ESG considerations into decision-making may also mitigate longer-term risks.

At an individual company level this might mean avoiding the risk of investing in a company that suffers a severe write-down in its asset base because it has relatively poor corporate governance and external reporting.

Or it might mean avoiding the risk of investing in a mining company that loses its social licence to operate because of poor industrial and local community relations.

In the global electricity generation sector, it could mean reducing "stranded asset" risks by reducing exposure to companies that have relatively high GHG emission profiles, in favour of companies with lower profiles.

New Zealand has shown some leadership in the sustainable investing field by being one of the founding signatories on the United Nations Principles for Responsible Investment, which is now the global benchmark.

The RIAA's five-year plan outlines a number of objectives to increase awareness and take-up of responsible investing in New Zealand.

In line with this, there are a growing number of sustainable funds available for New Zealand investors, provided by both local and offshore managers.

A recent addition to this is the launch of a NZ dollar hedged sustainable global equity fund by the global investment firm Dimensional.

While it is still early days, research on the new generation of approaches to incorporating ESG into investing and building portfolios suggests that it can improve portfolio performances, and need not reduce diversification benefits.

This is great news for New Zealanders wanting to mobilise their savings towards the development of a more sustainably focused economy.

This article was written by Aaron Drew and Lizzie Hill. Aaron is the chief investment officer of the Stewart Financial Group, whose head office is in Hastings. His show Real Wealth can be heard on Radio Kidnappers on Tuesday afternoons and on podcast.