Developing an ESG and Climate Investment Framework For Your Practice
Over the last few years, there has been a profound shift in the way investors think of environmental, social and governance (ESG) factors. The consequence is that ESG and climate portfolios are moving from an outlier to the norm. This presents an opportunity for financial advisers to offer a well-articulated philosophy, have broader conversations on these issues and support this with a credible investment approach and solutions.
Shifting Investor Preferences
of consumers now expect financial advisers to be knowledgeable about responsible investment options. 1
5 out of 6
Australians want the finance sector to act on climate change. 1
ESG themes in planner/client discussions in 2020 were renewable energy (59%), climate change (57%) & carbon reduction (51%). 2
Considerations for your Practice
Aligning financial advice with individuals’ motivations and values can be one of the most powerful ways to attract and retain clients.
ESG investing is rapidly evolving. As there are many shades of “green”, the process of building ESG and climate portfolios can be initially confronting. Taking incremental steps might be easier than one giant leap.
We believe that ESG and climate investing is a journey. We have created a practical framework to guide advisers in evolving and implementing an ESG and climate investment philosophy and approach. To get started on this journey, we list four initial considerations for your practice to reflect on.
Determine ESG Context
Determine your practices’ views/convictions on ESG investing.
Identify the relevant ESG priorities for your clients and your portfolios.
How will you prioritise exclusions and integration?
Set ESG Objectives
What are you trying to achieve? Client value, alignment, risk mitigation, alpha generation, regulation adherence or real world impact?
Does the ESG approach apply to all investor portfolios?
Degree of personalisation?
Develop ESG Investment Principles/Beliefs
Establish which ESG risks are most material to client portfolios and what asset classes are in scope for ESG integration
Define an approach for evaluating companies in controversial ESG industries.
Seek alignment with organisations with shared ESG principles (e.g. UNPRI).3
ESG Investment Strategy Selection
Set specific ESG criteria to evaluate investment strategies.
Select the optimal strategies that align with the ESG goals and preferences whilst maintaining diversification.
Constructing an ESG Framework
Once the above considerations have been acknowledged, the foundations of an ESG and climate investment framework can be formed. The framework is not intended to be a set-and-forget achievement. Client motivations will shift over time and the approach should adapt to changes in preferences, data, regulation and industry standards.
Having a framework will provide a disciplined process for your investment decisions. Further, it can connect to your client value proposition and discussions around how you invest and the benefits of that approach.
Five criteria to consider building into your framework include:
Negative screening is the process of removing investments in companies or sectors based on their higher ESG risks or activity involvement. A screen may be used to exclude the worst performing companies based on ESG criteria or to eliminate companies with unacceptable activities. Understanding the key ESG risks and portfolio impacts (concentration, tracking error etc.) are important considerations.
The Practice employs exclusions for commonly accepted ESG risks and controversies, such as controversial weapons and tobacco.
There is a clear philosophy articulating why these baseline exclusions are selected.
Exclusions are employed across a broader range of ESG risks such as thermal coal, severe ESG controversies or UN Global Compact Violators.
Negative screens may be applied to eliminate exposure to the worst performers on a range of ESG risks. E.g. remove bottom decile of high carbon emitters.
Apply a flexible approach to current and future exclusions as client demand and policies change.
The Practice can quantify the impact of the exclusions.
Investment Manager Considerations
Shared beliefs around exclusion methodology and metrics.
Investment managers source screening data from multiple, best-in-class sources.
ESG integration is the explicit and systematic inclusion of material ESG issues in analysis, portfolio construction
and investment decision making. Integration can help to manage ESG risk and enhance return but the degree of ESG integration will vary depending on the investment style (index vs. active, quantitative vs fundamental).
ESG reporting (profile, risks, opportunities) on client portfolios.
The Practice has a strong alignment of ESG integration across the Funds they have selected, which is consistent with their ESG philosophy.
ESG integration is applied across all asset classes, part of the Investment Committee agenda and embedded into macro views.
Positive impact can be measured and reported.
Investment Manager Considerations
Funds integrate ESG in their investment process, with a well-articulated investment philosophy, comparing risk and opportunities in portfolios.
Investment managers can demonstrate how they collect and process ESG data from multiple providers, as well as other external and internal research sources.
ESG integration is focused on those material trends that are more likely to drive asset repricing (e.g., the changing energy dynamic).
We believe climate change is the highest priority ESG issue facing investors and this is supported by industry research. It is a systemic issue which affects all companies, sectors and asset classes. It will have significant physical and economic impacts and introduces new risks and opportunities for portfolios.
Learn more about “Why Climate Should be Your ESG priority”.
The Practice understands their portfolios’ climate profile (risks and opportunities).
Climate considerations are an input into investment decision-making.
The Practice prioritises climate aware investing and can articulate the objective and approaches designed to limit the impact of climate change.
Investment Manager Considerations
Selected Funds seek to reduce high carbon and fossil fuel reserves exposure, with demonstrated reporting capabilities.
The Fund Managers selected have a firmwide commitment to achieve the Net Zero target.
Strategies seek both mitigation and adaptation approaches to climate change; supporting companies that will stand to benefit from the transition to the low carbon economy.
Investment managers seen as leaders in climate-aware investing through a multi-pronged investment approach; active ownership, green revenue, decarbonisation and exclusions.
Positive impact strategies prioritise measurement and reporting.
Engagement is the practice of shareholders entering discussions with company management to influence how the company is managed. Engagement can be a powerful tool to address material ESG issues and lead to positive change. Many institutional investors view engagement as a preferred path versus divestment, because it can help create more sustainable capital markets and lead to long term value creation for all investors.
Fund Managers selected have an established approach and process to company engagement and voting to address a broad range of ESG issues.
Detailed engagement outcomes reporting.
Fund Managers identify strategic ESG engagement themes to take a stance on the issues which have the most significant impact and are aligned with the firm’s ESG philosophy. E.g., gender diversity and climate change.
Best-in-class resources and approach to company engagement and voting. Strategic and highly active management discussions to ensure engagement is impactful.
When creating an ESG portfolio your practice will need to assess managers on their ESG and climate credentials and their commitment to meeting these challenges. Below is a non-exhaustive example of a Fund Manager’s assessment criteria.
Acknowledging that ESG investing is an journey, we recommend outlining your practices’ ESG and climate approach under “Base”, “Goal” and “Ambition” targets against these key criteria. This allows for a gradual improvement over time, reflecting a pragmatic approach to ESG integration across a diverse client base.
1Source: Banhalmi-Zakar, Z & Parker, E. 2022. From Values to Riches 2022: Charting consumer demand for responsible investing in Australia, Responsible Investment Association Australasia, Melbourne. 2Source: Investment Trends ESG Adviser Report 2021 3UNPRI = UN Principles for Responsible Investment
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Investing involves risk including the risk of loss of principal.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
This website is intended for persons resident in Australia. State Street Global Advisors, Australia Services Limited ABN 16 108 671 441, AFSL Number 274900 ("SSGA, ASL") is the product issuer. State Street Global Advisors, Australia, Limited (AFSL Number 238276, ABN 42 003 914 225) (“SSGA Australia”) is the Investment Manager. The material on this website is general information only and does not take into account your individual objectives, financial situation or needs.
You should seek professional advice and consider the Product Disclosure Statement (PDS) and target market determination, available at www.ssga.com, before deciding whether to acquire or continue to hold units in the Funds.
You can access our PDS online or by calling us. The offer made in our PDS is available to persons receiving the PDS within Australia and applications from outside Australia will not be accepted. Past performance is not a reliable indicator of future performance. Investing entails risks and there can be no assurance that State Street Global Advisors will achieve profits or avoid incurring losses.
Investing involves risk including the risk of loss of principal. This material should not be considered a solicitation to apply for interests in the Funds and investors should obtain independent financial and other professional advice before making investment decisions. There is no representation or warranty as to the currency or accuracy of, nor liability for, decisions based on such information. Performance quoted represents past performance, which is not a reliable indicator of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.