Building an investment strategy that considers the environmental, social and governance (ESG) impacts of business is critical for the managing risk in an SMSF.
Investment performance isn’t just driven by what is reported in financial reports or incorporated in analyst estimates. Companies that ignore the environmental, social and governance (ESG) impacts of their business leave themselves open to financial losses, brand damage, litigation and shareholder activism - ultimately risking their social license to operate.
As explored by MSCI (Morgan Stanley Capital International) in the research paper “Can ESG add Alpha?”, investing in a portfolio of global companies which have higher ESG ratings than their peers was found to outperform the benchmark by 1.1 per cent per annum with less volatility, thus giving investors a superior absolute return over the period of February 2007 to February 2015.
Investing in a portfolio of companies that are improving their ESG track records was also found to outperform, in this instance by 2.2 per cent per annum. Improvements help to re-rate the stock, reducing “potential future liabilities” that may be incurred while demonstrating that the companies are “equipped to avoid ESG-related risks”.
Investing responsibly is part of a trustee’s fiduciary duty, so taking into account the ESG risks that an investment is exposed to makes good financial sense. SMSF investors should be looking to incorporate ESG risk analysis into their investment process because, in essence, investing with an ESG lens is a proxy for quality. It’s an indicator that a company is stable, efficient and well managed, and marks those who are focused on sustainable long-term growth.
Taking a responsible investment approach is also a way to provide SMSF investors with the peace of mind that their super is being invested in the future that they want to retire in. SMSF investors with their own equity (and bond) portfolios are in a unique position to exclude companies involved in activities that they deem unethical.
They can also proactively invest in companies mitigating the risks of, and transitioning to adapt to climate change.
Those investing in funds can now access a growing range of responsibly invested and ESG integrated strategies in all asset classes, offered by over 70 managers. The Responsible Investment Association Australasia (RIAA) reported in their “Responsible Investment Benchmark Report 2016” that the average performance of responsible Australian share investment strategies which screen, or invest with a sustainability or impact theme, outperformed core peers and the S&P/ASX300 over one, three, five and 10 year periods. In global equities, the average performance of responsible investment strategies ranged within ±3 per cent of the MSCI World ex Australia over the same time periods, with some managers reporting stellar outperformance and others strong underperformance.
The importance of investment selection should not be underestimated and SMSF investors taking a responsible investment approach can potentially gain from the benefits of ESG risk management: lower volatility and thus higher long-term performance. Their ability to invest with the values they believe is their free-lunch to a good night’s sleep.
16 June 2017