Sustainable portfolios: A winning approach

By Jayson Forrest - Managing Editor  - IMAP Perspectives

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Deanne Baker is Portfolio Manager, Multi Asset at Lonsec
Deanne Baker- Lonsec
Leah Willis is Head of Client Relationships at Australian Ethical Investment
Leah Willis - Australian Ethical Investment
David McDonald, CFA Conference MC & Investment Specialist, IMAP
David McDonald, CFA - IMAP

These investor assets under management now position responsible investment with a 43 per cent share of the total market - up from 40 per cent in 2020. Investors are increasingly realising that they have an ability, through what they buy and invest in, to have a beneficial impact on the environment and society.

Leah Willis

We have a bottom-up process with our Sustainable Managed Portfolios, where we seek to make a positive contribution, while limiting exposure to controversial industries - like gambling, alcohol, tobacco, coal mining, nuclear, adult entertainment, and weapons. We believe ESG and sustainability are different, so we assess these risks differently, just as you would with other types of risks in a portfolio.

Deanne Baker

As part of the investment selection process, both ESG and sustainability are front of mind with our Sustainable Managed Portfolios. With ESG integration, we’re thinking about how well a manager integrates ESG into their investment decision-making process. And with sustainability - whether through impact, best-in-class, or exclusions - we want to ensure the investment seeks to do good and avoid harm.

Deanne Baker

These days, people are concerned about human rights abuses, slavery, and workplace exploitation. They are also more focused on sustainable transport, agriculture, and building. These are all complex issues that advisers need to be aware of when building sustainable thematics in client portfolios

Leah Willis

ESG and sustainability are two styles of investment management that continue to command the attention of investors. Leah Willis (Australian Ethical Investment) and Deanne Baker (Lonsec) discuss the rise of ESG and the role they play in client portfolios.

In an increasingly competitive and high profile style of investing, Lonsec has taken out the inaugural IMAP Managed Account Award in the category of ESG. In presenting Lonsec with its award, IMAP Chair Toby Potter says the development of the environmental, social, and governance (ESG) category, with support from Australian Ethical, recognises how important this aspect of investment management has become.

It was a view supported by Leah Willis - Head of Client Relationships at Australian Ethical Investment - who refers to the growing awareness and appetite of ESG and sustainable investing from investors.

Citing the Responsible Investment Association Australasia’s (RIAA), Responsible Investment Benchmark Report 2022 Australia, Leah says Australia’s responsible investment market reached $1.54 trillion in 2021, which is up from $1.28 trillion in 2020.

“These investor assets under management now position responsible investment with a 43 per cent share of the total market - up from 40 per cent in 2020,” she says. “Investors are increasingly realising that they have an ability, through what they buy and invest in, to have a beneficial impact on the environment and society.”

Some key takeouts from the RIAA report confirm that ESG integration, followed by negative/exclusionary screening, and corporate engagement and shareholder action, are the most popular responsible investing approaches used by managers in Australia.

“Consumer interest in sustainability-themed investments is high,” says Leah. “RIAA confirms that consumers using its Responsible Returns online tool (1 January-31 December 2021) are searching  for a variety of ESG investing options, such as renewable energy and energy efficiency (16 per cent), sustainable land and agriculture management (12 per cent), and sustainable water (10 per cent).

“And investment structures, like managed accounts, provide advisers with a great solution to be able to engage in the ESG and responsible investing space in a scaleable way.”

Sustainable portfolios

At the 2022 IMAP Managed Accounts Awards, Lonsec got the nod by the judges for the ESG category, taking out this inaugural award for its whole of portfolio solution and approach to ESG. According to Deanne Baker - Portfolio Manager, Multi Asset at Lonsec - Lonsec’s Sustainable Managed Portfolios are a multi-asset solution that incorporates ESG and sustainability principles across the major asset classes.

She says the aims of the portfolios are not only to deliver strong risk-adjusted returns but to also make a real world impact. This is achieved by making a positive contribution to the key environmental and social challenges facing society, as measured by the United Nations’ 17 Sustainable Development Goals (SDGs).

“We have a bottom-up process with our Sustainable Managed Portfolios, where we seek to make a positive contribution, while limiting exposure to controversial industries - like gambling, alcohol, tobacco, coal mining, nuclear, adult entertainment, and weapons,” says Deanne. “We believe ESG and sustainability are different, so we assess these risks differently, just as you would with other types of risks in a portfolio.”

And while Deanne concedes that the portfolios may not have the lowest carbon footprint, Lonsec continues to work diligently for alignment with the Paris Agreement to limit the impacts of climate change.

Research approach

Fundamental to Lonsec’s investment process is its approach to research. When it comes to ESG, it looks for managers that are true-to-label. The research team, which consists of over 40 analysts, uses proprietary systems to assess and score funds on an ESG and sustainability criteria, which Deanne says is essential for avoiding ‘greenwashing’.

“We avoid greenwashing by leveraging the depth and breadth of Lonsec Research,” she says. “We do this by assessing a manager’s ESG integration using the framework provided by the broad parameters of the United Nation’s Principles for Responsible Investment, of which there are six principles. We use our ESG BIOmetrics, which measures the degree of ESG awareness practiced by the investment manager with respect to the product under review.”

Lonsec also undertakes a bottom up assessment of the goods and services produced by companies in the portfolio, including their impact on society and the planet. Funds covered by Lonsec are issued with a ‘sustainability score’ (ranked in the allocation of ‘bees’), which reflects the underlying investments of individual products and their compatibility with the United Nation’s 17 SDGs.

“The ‘sustainability score’ is a quantitative estimate of the net ‘goodness’ in a portfolio. The score nets the positive contributions to the 17 SDGs against the negative impact of exposures to controversial industries from the activities of the companies held in a fund’s portfolio,” she says. “The ‘sustainability score’ reflects the net impact of these measures, which is peer ranked and results in a score of between one and five bees.”

According to Deanne, the ‘sustainability score’ was introduced to help advisers and their clients navigate the often confusing sustainability landscape, and to give users an understanding of how well an investment structure - like a managed account or ETF - lives up to its sustainable credentials.

“While we don’t believe there is a ‘perfect’ company, our research approach is effective in searching for managers that offer genuine sustainability and ESG, and ranks highly with our ‘bee’ score.”

Investment selection process

Lonsec maintains a qualitative and quantitative approach to investment selection. This includes face-to-face meetings, holdings-based analysis, risk and return analysis, style/factor analysis, and forward-looking scenarios analysis.

There is a five-step process for investment selection, which begins with a ‘quality filter’, where investments are screened based on a rating of ‘recommended’ or above. The second step ascertains the investment’s appropriateness and role in the portfolio, the third step is due diligence, while the fourth step is about blending and risk control. Only when these four steps have been satisfied, does an investment go to the fifth step - manager selection committee approval for final sign-off.

“As part of the investment selection process, both ESG and sustainability are front of mind with our Sustainable Managed Portfolios,” says Deanne. “With ESG integration, we’re thinking about how well a manager integrates ESG into their investment decision-making process.

“And with sustainability - whether through impact, best-in-class, or exclusions - we want to ensure the investment seeks to do good and avoid harm.”

More complex issues

Through her work at Australian Ethical Investment, Leah is at the coalface of rapidly evolving investor demands with ESG, ethical, and sustainable investing. And while there are obvious exclusions to investing - like gambling, tobacco, nuclear energy, and weapons - there is an ever-increasing list of more complex issues that are attracting the attention of Australian investors.

“These days, people are concerned about human rights abuses, slavery, and workplace exploitation. They are also more focused on sustainable transport, agriculture, and building. These are all complex issues that advisers need to be aware of when building sustainable thematics in client portfolios,” says Leah.

Accessing and using industry data to compare funds and investments is another complex area that advisers need to navigate. And while Leah believes ESG and sustainability data is improving, there’s still a way to go.

“There’s still a lot of gaps in the data available in the market, which isn’t helped by the different methodologies that providers use,” she says.

Deanne agrees, adding that Lonsec is limited by the quality of ESG inputs provided by managers with their investments. “That means we use a lot of NGO and government inputs, because we understand we’re not going to get the level of reporting from companies that we want,” she says. “However, we’re hopeful that will improve over time.”    

About

Deanne Baker is Portfolio Manager, Multi Asset at Lonsec; and

Leah Willis is Head of Client Relationships at Australian Ethical Investment.

They spoke at an IMAP Best Practice webinar on what best practice means when constructing ESG portfolios.

The session was moderated by David McDonald CFA - Investment Specialist at IMAP

 

 


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