An ethical and sustainable approach

Perpetual kicks goals with Mainstream SMA

A panel of Environmental, Social and Governance (ESG) experts discuss the growing move towards ethical investing, and the challenges involved in incorporating ESG into the investment process. Arranged with the support of Refinitiv.


  • Amanda Munro – Chair, Portfolio Management Group, IMAP
  • Daniel Nelson – Senior Research Analyst – Direct Equities, Perpetual Private
  • James Freeman – Philo Capital
  • Paul Hewitt – Client Specialist Manager, Refinitiv
  • Ronan Leonard – Market Development Manager, Wealth – Pacific, Refinitiv
  • Dr Stuart Palmer – Head of Ethics Research, Australian Ethical
  • Toby Potter - Chair, IMAP
  • Trevor Thomas - Managing Director, Ethinvest

Q: How does ESG underpin your approach to investing?

Daniel Nelson: At Perpetual Private, our clients tend to be high-net-worth or not-for-profit organisations. So, the integration of ESG into their investment portfolios is usually quite important for them. From our broad group of clients, we took the time to find out what they really care about when it comes to investing and from there, we created our ESG methodology around that. 

Stuart Palmer: When we work out the risk return profile of potential investments, we look at the impacts that investments have on the planet and not purely as part of our financial risk analysis. So, we don’t care what our valuation model is saying around a tobacco company or a fossil fuel company. The company may be extremely good value, but we’re not going to buy it due to our ethical position on investing.  

Trevor Thomas: Most ethical investors walk in the front door expecting their money is going to be doing good things in the world, and not just avoiding bad things. 

We start by asking our clients what they’re after in their portfolios. Our experience is that clients have zero tolerance for unethical investments and want to avoid them. I’ve never had a client tell me they have a 15 per cent tolerance for tobacco or a 5 per cent tolerance for gambling. They just don’t want to see these types of investments in their portfolio. 

So, we start with what they want and we build a portfolio around that. But because of that nuance, the number of managed funds we can use gets restricted, so we end up building lots of direct share and investment portfolios to specific mandates. 

We engage in conversations and we do quite a lot of shareholder activism. Where we see unethical practises we want to change, we will buy shares for clients in the company and then put a resolution to the AGM. By doing so, it gets us meetings with those companies.

However, divestment isn’t our only option. We can be responsible owners as well.     

Stuart Palmer: We are also involved in activism. Within the universe that we screen, we still don’t find perfect companies. However, we do have engagement and advocacy with the companies we do invest in. But similar to Trevor, due to our position on ethical investing, there are companies we don’t hold, like Santos or Origin Energy, because we think there are a lot of issues around gas, particularly unconventional gas.

James Freeman: ESG is really about tailoring to individual advice firms and their clients’ needs. One of the advantages of Philo Capital is that by offering a service to different advice firms, these firms can bring their own investment philosophy around ESG that is particular to their client base. 

However, the degrees of sophistication around ESG ranges. Some firms know exactly what they want and have thought it through, while others are just exploring an idea or an opportunity that had not previously been available to them. So, we help them understand the trade-offs that come with the tactical implementation of ESG investing.   

There’s also the opportunity for clients to take a bottom-up, granular approach to investing, where ESG exclusions or concerns can be expressed in the portfolio, overriding a top-down model portfolio approach.

Trevor Thomas: Our clients are generally looking to be consistent in the way they run their lives, including bringing their investment choices into line with their beliefs.

The conversations we have with them about specific investment opportunities then prompt our clients to begin rethinking some of their investment choices, like banking, particularly in the aftermath of the Royal Commission. In fact, many of our clients changed their shopping behaviours when they discovered Woolworths’ involvement with owning poker machines.  

Q: How do you form your ethical view when it comes to investing?

Stuart Palmer: We have an ethical charter which is part of Australian Ethical’s constitution, since we established over 30 years ago. That ethical charter doesn’t change. It’s principles-based about the things we stand for. This includes finding investment opportunities that provide a positive impact on people, animals and the environment. We avoid investing in companies that are causing unnecessary harm to people, animals or the environment. 

And while this is easy to say, it’s often extremely challenging to apply in practise, because virtually every companies’ business activities are going to derive some benefit that may impact, directly or indirectly, people, animals or the environment. 

We have developed frameworks that allow us to examine sectors, like banking, property and energy, and how they impact our principles-based approach to investing and what we need to worry about when looking at companies operating in these sectors.

Those frameworks get developed over time. From the very beginning, climate change has been at the centre of our framework development. Our expectations around what companies do to limit global warming by 1.5 to 2 degrees, means that our standards rise overtime. 

Our charter is just as relevant today as it was three decades ago. The charter embeds both positive and negative elements of our view towards the way in which companies operate. The way in which we do analysis revolves around: what is the product and service that is being delivered, and do we think it’s part of a sustainable world?

If we think the product and service is good, then we determine if the company is delivering their product/service in a way that is properly managing its impact on people and the environment.

For example, if a wind farmer or a solar farm developer is ridding roughshod over local communities, then we may screen them out at that stage. So, despite loving their product and service, if we don’t like how they do business, then we screen them out. 

Q: Looking at the universe of stocks, what percentage of them would be screened out?

Stuart Palmer: About 50-70 per cent of the market would be screened out. There is a huge variety of companies that fail the ethical investing test, like tobacco, that can be screened out. So, we end up with portfolios that are very different from mainstream indicies. 

Trevor Thomas: One of the problems for advisers and retail clients with ESG is the amount of ‘greenwash’ and misinformation in this sector. Greenwashing is a form of spin in which green PR or green marketing is deceptively used to promote the perception that an organisation’s products, aims or policies are environmentally friendly.

There are probably three dozen advisers in Australia who are really specialised in the area of ESG, of which it is their core business. Recently, we have begun providing scores out of five green leaves across all of the major ESG funds. Australian Ethical scores extremely highly on the five green leaf scale, whereas many industry super funds’ eco options score very poorly, with the field scattered between 1.5 and 4.5 green leaves.

There are many ESG funds in the market that cost more, but look very similar to the company’s typical ASX100 or ASX200 fund, and that’s something advisers and investors need to be aware of. 

They might drop the pure play exposure to gambling, alcohol and  tobacco companies, but they still hold the big supermarkets, the big banks and the diversified miners. That’s because companies can score very well if they’ve got great ESG policies. For example, BHP scores brilliantly on a number of indigenous and environment policies, but it still owns the world’s largest uranium mine. So, if you are concerned about uranium, then BHP needs to be screened out.

Q: If we are concerned about climate change, can nuclear power be the solution to our energy needs, without pumping more carbon emissions into the atmosphere? 

Stuart Palmer: We get asked that a lot. There is the ethical judgement around balancing the interests of people, with the needs of animals and the environment. So, part of our ethical research looks at the scaleability of renewables. For example, do we need nuclear and how do we manage the risks around it, such as some of the product being used for weapons? We throw all that into our analysis, but we still end up with a very clear decision that justifies the exclusion of nuclear for Australian Ethical.

Our members care deeply about all humans, animals and the environment. So, it all comes down to what is going to produce the best investment outcomes for them. Ultimately, there are a lot of issues around nuclear. It’s a question of balancing the risks versus the rewards.

Also, our investors will weigh their interests differently. Some people will be very concerned about any form of animal farming or animal testing, while others are happier to trade that off for human wellbeing. 

Trevor Thomas: And things change. Our thinking changes. It’s not fixed forever. For example, 20 years ago, gas was in Australian Ethical’s portfolio, because everybody was talking about it as being a transitional fuel. But today, it’s not because we know more about it.

Daniel Nelson: It all comes down to where you draw the line on things like nuclear power, or genetically modified food or animal testing. For us, nuclear power and uranium is out. As for animal testing, we believe that if it’s for cosmetic purposes, it’s out. But if it’s for proper medical purposes, we’re okay with that. 

It does come down to the individual client and what they care about. So, we have developed our screening and filters that we believe satisfy most of our clients with their ESG requirements.

Q: What are the challenges involved in incorporating ESG into the investment process?

Stuart Palmer: We get direct feedback from some of our members who, for example, tell us they don’t like the big four banks. So, if that’s a deal breaker for them, they won’t invest in our funds. That’s one of the reasons we are looking at developing an ethical SMA; to provide flexibility around this issue. But there is a big difference between people who say they prefer you not to be invested in a company or sector, and those who will actually go somewhere else as a result of it. 

Once clients understand we are genuinely working hard to navigate all those shades of grey in ESG, the fact that they might fall on the other side of the line with a judgment call about, say, animal testing for vital medical research, becomes less important. 

And while it’s obviously vital that we listen to our clients and communities, we also need to exercise our expertise and judgement with making investment decisions, and share our reasons for these positions with our clients.

James Freeman: In that respect, scale comes into the equation. The amount of thought, research and analysis that you are able to dedicate to ESG issues, vastly outweighs the time an individual can spend doing the same thing.

Aligning the investor’s values to what’s in their portfolio, and the value that can provide from a behavioural finance perspective, is huge. So, the comfort investors can gain from understanding the investing process is very important.

Q: What do you take into consideration for reappraising a company that is seeking to get on your ethical investing radar? What steps do companies need to make?

Stuart Palmer: Let’s look at a company like AGL as an example. It still owns a lot of coal generation infrastructure, but it might be doing as much as any company in trying to transition its offering. So, you could argue to support it. But under our process, we would still screen AGL out because we have revenue thresholds for energy generation. If they are above the threshold for fossil fuel power related revenue, which they are, then they’re going to be out. 

If you are going to screen companies, you need thresholds. However, we do invest in Contact Energy, which derives about 20 per cent of its revenue from gas but 80 per cent of its power is geothermal and hydro. And as a company, it is continuing to invest in hydro, and the gas allocation, which is used for periods when there may not be enough rainfall for the hydro, is not increasing.

And when there is a major cultural issue within a company, as we have seen with AMP and IOOF, when enough bad things have and continue to happen, then not only will we not be investing in that company, but a period of one to three years needs to pass before we will consider reinvesting in them. This period is to allow the company to fix systemic cultural issues. 

Trevor Thomas: The approach we take is the same. It’s three years for bad corporate behaviour. However, if the matter goes before court, we don’t make any exclusions until the court rules. The accusation needs to be first proved. 

The beauty of our approach is that even though we do run some SMA models, most of our clients make their own decisions concerning whether they stay with a company or not.

Stuart Palmer: With bad corporate behaviour, you can wait for the relevant claims to be fully aired in court, or you can sit somewhere in the middle, as we sometimes do. For example, if somebody is appearing on the front page of the newspaper for all the wrong reasons, that’s still not a reason for us to get out. We consider all the merits first and speak to the affected company involved.

Q: To what extent do you consider the ability for a company to provide employment to the wider community when making your investment decisions?

Stuart Palmer: For us, it’s about building a better and more sustainable economy and society. Jobs and meaningful work are all part of that better future. However, I don’t think jobs alone are a reason to stay invested in something when we don’t like the product or service. 

The argument that we stay in coal because the industry employs many people, is not a good or strong enough argument for staying in an old and harmful technology. The onus falls on governments to contribute capital to transition people to jobs in sustainable industries.

Trevor Thomas: And the companies themselves are asking how they can employ less people to dig up the same amount of coal or do the same amount of work. They are not asking how they can create more jobs. It’s all about mechanisation and enhanced profits.

Stuart Palmer: It’s a transitional issue. You can’t deny change for the sake of change, particularly when there are better and more cost-effective ways of doing things.

Daniel Nelson: When it comes to employment, it’s all about the quality of those jobs and the environment in which employees are working.

Stuart Palmer: History has shown that despite worrying about printing presses and weaving machines putting people out of jobs, technology has enabled us to actually get rid of the nastier jobs, while opening up new opportunities for interesting and rewarding jobs. 

We are at a point where artificial intelligence will surpass human capacities in certain areas, so things may change rather radically now.

We continue to invest in innovation, because we think it’s a positive thing. But I can imagine there will come a point where, as a society, we need to decide whether we put a brake on innovation to maintain the level of employment or do we become more expansive with our thinking and explore other alternatives, like reduced working hours. 

As a society, maybe we are too hung up on a career and a 9-to-5 job as a source of meaning in our lives.  

Q: Are companies that embrace ESG more sustainable over the longer term?

Stuart Palmer: I think the debate has moved on about there being a trade-off in performance between ethical/ESG funds, and mainstream funds in the market. More people are realising the need to stay away from certain investment areas that aren’t being well managed, because they carry big risks of adverse Government regulation and consumer backlash.

Trevor Thomas: The underperformance myth of ESG is a self-serving lie that is perpetuated by some within the industry. You have never had to sacrifice returns to invest ethically in Australia.

Our portfolios are embarrassingly above the benchmarks every quarter. And sure, it’s because we are taking bigger risks, because we are fishing in smaller ponds where companies aren’t increasing their profits by minimising their tax aggressively, or not screening their environment or stakeholders in order to make returns. That’s the type of company I want to invest in. A company that is profitable without cheating.  

Paul Hewitt: The Bank of America has done a huge amount of research on ESG, and it’s seeing significant gains over the benchmark for companies that incorporate ESG.

People look for positive trends in companies. ‘Diversity’ is a classic example, where people are looking for companies that have a diverse board, to ensure it’s not at risk of ‘group thinking’, which can lead to unchallenged decisions that ultimately, can lead to a company going down the wrong path. 

Q: Do investors grow out of their ethical investing views and what type of demographic is attracted to ESG?

Trevor Thomas: The ethical client is incredibly sticky, because they are very tightly committed to the program and objectives you are helping them to achieve. 

We provide a narrative about ESG. We tell them what their investments are doing. We’ve got clients who have held the same companies for 15 or 20 years and you keep updating them about what they’re doing.

Most companies that are working in positive areas are increasing their footprint. For example, we’ve got clients who have held Sims Metal for 15 years, but it’s not the company it was 15 years ago. It has invested in a whole range of new products and services over that time. So, we tell the story.  

ESG is particularly strong with people aged under 35. This generation is not impressed by ESG-tilts. They have strong absolute values they want to reflect in their portfolios. So, at the retail level, the conversation around ESG is essentially black and white.

The war on waste has had a huge impact on people’s thinking about plastics and recyclables. Climate change awareness is now mainstream, which crosses over all demographics. However, there is an acceptance for people aged under 35 that climate change is real, and it’s going to impact and affect their lives badly. But they feel we still have time to do something positive about it.

Our business is structured around individually managed portfolios, and the average portfolio size is $1.5 million. So, there aren’t too many Millennials knocking on our door with that type of money, yet. The average age of our clients sits around 55-years-old and they come to us because they know we specialise in ESG. They are incredibly loyal.

We are also increasingly talking to the adult children of our clients, particularly in relation to generational wealth transfer. 

Daniel Nelson: Many of our clients tell us they are not interested in the ‘responsible’ portfolio, but inform us that when they go, their children will want this ‘responsible’ portfolio in the trust that our clients leave them. So, in that respect, there is more interest in ESG from the next generation of investors.   

However, I do feel that the demographic towards ESG investing is changing. We have a steady level of interest from our existing client base towards ESG. So, interest is definitely building.

Stuart Palmer: We can feel optimistic about the trend towards ESG. What gets a lot of people excited, both the younger and older generations, is climate change. The polling that we and the Responsible Investment Association of Australia (RIAA) conduct, reveals a disconnect between what people expect around climate action and what’s actually happening. People want to see real effort put into ESG issues, like climate change, that creates meaningful and sustainable change.

Q: To what extent is data and information available on ESG in other markets outside of Australia?

Stuart Palmer: We only operate in developed markets, so we do get a good flow of data and information from these markets. However, our access to overseas companies is different, compared to here. So, opportunities for engagement with these offshore companies is less. 

We do take account of different practises in different markets. We accept we will receive less responsiveness from Japanese companies compared to European companies. But that’s changing. 

However, the ESG data providers are still operating globally and rating companies globally, and that’s where we do rely a lot more on these sources of information, compared to our own research on local companies.   

Trevor Thomas: There is a lot more choice today for the retail investor to get exposure to global equities or assets. A lot of these are specialist managers from overseas that have a portal into Australia, which gives us more flexibility in building portfolios than we’ve had previously.

And when it comes to ranking managed funds, transparency is the first rule in ethical investment. So, if the fund manger won’t tell us what they own, then they are immediately given a low ranking based on suspicion, with the likelihood we won’t use their fund. 

Daniel Nelson: Perpetual Private does have a full suite of asset classes. While we do use external fund managers, we still keep to the same principles and ensure those fund managers satisfy what we want them to do. 

Q: How does investing in China – the largest economy in our region – influence your approach to ESG investing?

Stuart Palmer: We do have a government framework, which outlines what governments we will and won’t invest in. We like democratic and legitimate governments. We don’t like autocratic governments. 

So, we’re not investing in Chinese Government bonds, but that doesn’t mean we will rule out investment in companies operating in China, or indeed, Chinese companies. In that respect, what we look at is whether these companies are complicit in facilitating the things we don’t like about the Chinese Government and its economic activity, or do we see them as being a force for good in that country?

An example would be social media companies – like Facebook, Google and Twitter. In this case, we’re looking at what they are doing when they seek to offer their products and services in China. What concessions will they make about allowing Government access to their data, which could be used to impede the civil liberties of its citizens? What type of censorship will be imposed on these platforms to enable them to operate in that country?

But I understand these companies have stayed out of China because they haven’t been prepared to sign up to the Chinese Government’s requirements. However, if they did agree to some of the requirements and we thought these companies would encourage greater openness and greater freedom of speech within China, then they could be a force for good, in which case, we would consider investing in them.  

Trevor Thomas: One’s beef is with the Chinese Government, not the Chinese people. So, Australian and other overseas companies that want to sell to the Chinese, have to negotiate Chinese regulations. 

For example, if you want to sell medications or cosmetics, then these companies have to go through the Chinese Government’s requirement that they are all tested on animals. That has implications for investors who are concerned about those issues. 

So, we have to be open and honest about which companies have had to go through that process and allow clients to make up their own minds.

Stuart Palmer: If a company is developing cosmetic products and testing them on animals, then regardless of whether they are looking to go into China or not, we automatically rule them out. When it comes to vitamins, Blackmores is looking to be licensed directly in China, which would mean animal testing of its products, as part of Chinese regulation. This would then be a reason for us to divest in Blackmores.    

Trevor Thomas: Blackmores is an interesting company. Our clients hold them because of the positive way in which they treat their staff and the amazing work it does in terms of the environmental management of its footprint.

Q: What is your view on managed accounts?

Trevor Thomas: It would be much more efficient for us to run managed accounts, because currently, every advice recommendation we make has to be authorised by the client before we can change it in their portfolio. So, I believe managed accounts are well suited to the ESG space.

It also allows easier customisation. People have idiosyncratic views about companies that they want to either include or exclude. Managed accounts can accomodate that perfectly. 

Stuart Palmer: We are developing an SMA. A big part of my job is justifying why we are invested in certain companies, so it would be more efficient to provide greater customisation to clients to enable them to screen out certain companies.

Disclosure of interest: IMAP Chair, Toby Potter is a shareholder in Philo Capital Advisers. 

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