Expert Insight

Where the ESG rubber meets the road

ESG reporting is necessary but culture is crucial and not to be neglected

April 29, 2020

Tal Lomnitzer

March 12, 2020

ESG and sustainability have become buzzwords; barely a day passes by without mention. Rising pressure from investors and regulators is driving money towards companies considered ‘good’,arguably improving the availability, and reducing the cost, of capital.According to the Global Sustainable Investment Review 2018, sustainable investing strategies now represent 26% of all investment assets under professional management in the United States.

As sustainability creeps up the public agenda, asset managers and asset owners are increasingly considering it as a third dimension to complement risk and reward. Evidence is mounting that company performance and thus investment returns can improve by adhering to an investment approach that integrates ESG factors. It is a genuinely power fultrend, akin to an unstoppable train that is picking up speed.  

Particularly in the resources sector, a robust, responsible and quality-driven investment process should always consider ESG factors as a quality identifier and risk mitigant. ESG factors are intertwined with license to operate and are arguably of more importance for resources than any other sector given its extractive nature.Companies that perform well when benchmarked on ESG measures have tended to face lower idiosyncratic risks, which often leads to better risk-adjusted returns. In the past few years, ESG has moved from a risk control to an opportunity, which can drive revenues and expand (or protect) margins for certain companies while compromising the same for others.

As ESG and sustainability gain popularity, many corporates and money managers are taking the opportunity to extol its virtues. Concerns now arise as to what extent it is becoming a box ticking or ‘greenwashing’ PR exercise. Sustainability and ESG are complicated multi-layered subjects with many factors that are sometimes hard to measure quantitatively and lend themselves to qualitative description and judgement.What is considered material and important by one person may seem trivial to another and claims around ESG may lend themselves to hyperbole and obfuscation. 

The past 10 years was about ESG awareness and the next 10 years is going to be about data quality,consistency and monitoring. It’s not good enough to say that ESG is important and integrated. Increasingly, a burden of proof will rest with the fund manager to show how it is integrated against objective numbers. Measuring the outcomes of a portfolio and showing that it has a lower carbon footprint, lower ESG risks, higher water efficiency, better safety, or more socioeconomic benefit are becoming possible and should be demanded by investors. 

The next step is to identify and attempt to measure the contributions that the resources portfolio makes to United Nations Sustainable Development Goals.Complexity abounds here. Extracting copper comes with a cost to the environment but the copper that is produced is key to decarbonising the global economy by virtue of being the conduit through which electrons flow. No copper means no electric vehicles. Similar arguments can be made for nickel, lithium, cobalt,iron ore and so on. Furthermore, the fiscal contribution from resource extraction can make a major contribution to local and national economies (often in the developing world). The jobs created and associated multiplier effect can trickle down to positively impact thousands of people.

The leading edge of ESG integration takes these various impacts into account and attempts to measure the net impact of positive and negative externalities of a portfolio on the global economy and society at large. To this end we encourage companies to move towards integrated reporting, which looks at value created for multiple stakeholders.

What is lacking is consistency in reporting and auditing of that data

This may begin to address one of our frustrations as resources investors – how many investors automatically shun the resources sector. The fact is that without resources the world cannot function or feed itself; resource companies play an integral role to help the world decarbonise and develop sustainably. Therefore, we think avoiding resources is self-defeating for investors that want to encourage global development and improve portfolio returns. Indeed it can be shown that adding resources to an equity portfolio can improve returns and lower volatility.  

For years, there was a frustrating lack of data and our engagement with companies was aimed at improving disclosure. That has changed and there is now plenty of data. What is lacking is consistency in reporting and auditing of that data and it is here that there is work to be done. We would like to see ESG move from the front half of the annual report to the back half – where it should be audited and consistently reported. 

Producing ESG data today is entirely at the discretion of the corporate entity in terms of what is disclosed and when. A number of initiatives such as the Sustainability Accounting Standards Board (SASB), Carbon Disclosure Project, The Task Force on Climate-related Financial Disclosures and Global Reporting Initiative are pressing for more widespread standardised disclosure of data and it appears likely that the extent of ESG reporting will continue to increase and become more comparable and reliable in the future. Ultimately, we hope that the SASB is absorbed in the Financial Accounting Standards Board in the US. This would lead to integrated ESG reporting into financial statements. Concerns around data integrity, timeliness, universality and comparability would evaporate.

These demands for disclosure are increasingly collective. As a member of the global investor initiative on tailings facilities, Janus Henderson is an advocate for the call for uniform tailings data disclosure in financial statements. We urge all mining companies to engage in this conversation, or risk being left behind. As universally accepted standards for ESG compliance and disclosure emerge,  mining companies and asset managers who do not truly understand that providing for the needs of today should not come at the expense of the needs of tomorrow will be exposed. Our resources funds currently demonstrate around 40% lower carbon footprints, lower controversy risk and lower overall ESG risk than that of our benchmark*.

Standardised reporting anddisclosure also comes with a health warning: whilst necessary, it is not a silver bullet.

There is danger that highly-standardised ESG reporting results in box ticking, providing excuses for inaction. As active managers we will continue to scrutinise the quality and sincerity of the companies in which we invest. Investing in high quality companies demands that we assess culture. It is culture that binds environment,society and governance together alongside company financials. People and planet are the pillars that support profitability. For us, that means hard hats and steel-toe capped boots will remain investment tools as important as spreadsheets and annual reports. Culture is most effectively assessed by getting out there and talking to people in the field, as well as those in the C-suite.

This is where the ESG rubber meets the road.

*Source: Janus Henderson Investors as at 31st December 2019 supported by ISS Carbon Footprint and Sustainalytics data.  Fund referenced is the Janus Henderson Global Resources Australian Unit Trust. Benchmark referenced is the S&P Global Natural Resources Index. Data is correct as at publish date but may vary and is subject to change.

April 29, 2020

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