Towards an ESG Advisory Framework : An Interview with Andrew Marchant, CIO – Minchin Moore

A: It’s like society – there’s a cross-section. When you look at a particular issue, you'll find some people who are passionate about it and want to reflect their views through every aspect of their life. Then there are people who are interested, open to having a conversation, and maybe adapting their behaviour or approach to something that's a bit new. And you have people who are just not interested at all.

We’ve provided training to our advisers to help them have that conversation with clients, and to do it in a way that doesn't reflect any judgment or push an agenda. The aim is to learn about our clients first and find out what’s important to them. The answers they’ve shared have thrown up a lot of new insights that advisers would not have discovered if they hadn’t asked a couple of open questions.

I think there's latent demand for this discussion. People tend to be interested in the big issues, particularly on the environmental side a lot more now than 10 years ago.

My sense is that there's a higher proportion of younger people, who are still accumulating wealth, who are interested in reflecting their values through their portfolios.

A: The main topics that come up are climate emissions and fossil fuels and everything related to that realm, and the so-called ‘sin’ industries, particularly gambling as a sector, that people want to avoid.

We have a few clients who are seeking to deploy capital in future-proofed industries. They’re looking at the areas that are going to be involved in the transformation of energy transmission and want to invest in them. The environment is a really important consideration for a lot of clients.

A: Our investment philosophy and approach is the foundation of our value proposition to clients.

When we started looking at incorporating an ESG approach, one of the non-negotiables for us was that we wouldn't do it in a manner that was inconsistent with our investment philosophy.

We're very textbook in the way we go about investing. We use modern portfolio theory. We diversify broadly. We use evidence to help inform us about the efficacy of active management and the value of forecasts. We control the things we can control and that make a big difference: costs and investor behaviour. We weren't prepared to compromise on these fundamental philosophical tenets.

And so we've been patient. We’ve waited to bring in investment ideas until we were comfortable that we could do it in a way that didn't compromise our investment principles. Another consideration is whether there is a financial compromise from incorporating ESG into portfolios.

However, we're confident that our current approach does not compromise the financial outcome. There have been some important advances in product development, which allow us to incorporate ESG but be very confident that we're still diversifying broadly; that we're going to achieve the market return; and that we can do it at low cost. They're the three big elements.

A:The most important driver of returns is the capital markets themselves. That’s our view, and to that end we want to access those capital markets as effectively as we can.

It follows that we should only accept variations – whether it's from active management or a systematic approach that has tracking error – if we're confident that the market return after fees can be achieved.

We accept that by varying the portfolio from the structure of the underlying market there will be periods where the portfolio may have a higher return for a period, or a lower return.

Within the asset classes, we seek to construct portfolios in a way that manages the risk of variability through the investment cycle. If we can incorporate rebalancing to take profits when parts of the portfolio are doing better than expected, and invest more in those that have underperformed, then we're confident that we can keep the rhythm of the constrained [ESG] portfolios consistent with the non-constrained portfolios.

It’s important to educate clients about the variability of returns. Variation represents risk, which plays a role in delivering the ultimate return.

A: I’d be cautious about claiming that it has created client opportunities. What I would say is that as our advisers have become more confident about having the discussions, no matter what their own views are, broadening the conversation beyond pure financial matters, has improved the depth of the relationship. That is really the key to building an advice business that generates good ongoing momentum in referrals and engagement with other members of the family. The ESG part is just one element of that. We want to have that deep engagement with the members of the family, regardless.

But it has piqued interest in families who are trying to engage the next generation with management of the money. We've found some really passionate young people who are inheriting wealth who want to have a say on how the capital's being deployed.

For example, two of our clients, who are in their late 20s, will inherit a significant amount of wealth from their parents. For them, the discussion about asset allocation and diversification was a functional process that they had to do. But when we started asking them about their values and what was important to them, their engagement grew significantly. And our connection with them improved. They became really animated about what their thoughts were about the environment, in particular. They were particularly upset by the inclusion of Rio Tinto in the portfolio, because of its 2020 blasting of Juukan Gorge.¹

We went on to have a good discussion about what aspects of their values can be implemented in an investment portfolio; what parts might need to be expressed through, say philanthropy; and what parts might need to be expressed through the political process.

That was pretty powerful. Without having that conversation, our connection with these clients would not be as impactful. Our role as advisers is to help them to have the greatest confidence that their money is achieving their goals, and not just financial goals.

A: You have to be clear about what you stand for when it comes to investing and have confidence in your approach. Be prepared to be patient until you can appropriately source investments that help you to execute your investment approach with your clients. For us, costs are a high bar. As well, wanting to diversify broadly is key.

And so what that meant was that we weren't able, we still aren't able, to execute ESG in all the asset classes. Across a portfolio, it’s been a process of bringing investments in when we've been comfortable that the tenets of our investment philosophy can be met.
There is a lot more choice now, and a lot more nuance. That means there are a lot more solutions that are suitable for the broad client base looking for lower cost and diversified investments.

But even today, there are still challenges as we go deeper green² or towards the impact investing space.³ These are still very much the preserve of the wholesale client. Partly because lack of liquidity is an issue, and also because a large amount of investment capital is generally required.

Another challenge is assessing whether a fund’s ESG integration is going to achieve what you want. I think you must be very careful to assess how serious the fund manager is about developing genuine ESG-focused products.

A: Yes. One of the inputs in our process is reporting. When we engage with a fund manager, we review their impact reporting.⁴ We have a conversation with the manager about their commitment to impact reporting and then we track that reporting over time to make sure it is reasonable and effective.

We want our clients to know what their investment capital is achieving. I expect that, as clients become more engaged, there is going to be more pressure on managers to be accountable and show what they're doing.

A: Yes, I do. And it definitely is a very important element of the approach and implementation side of things.

It’s important enough for a lot of people that they're changing the way they live in order to minimise the impact that they have on the planet. They're dealing with it politically, and in their friendship groups and the people that they engage with. They’re exploring what a future world looks like that’s far more climate-focused.

At Minchin Moore we’re huge believers in capitalism. It's at the centrepiece of our entire investment philosophy that we have great confidence in capitalism’s ability to find better ways of doing things, and deploying capital in a more efficient way to drive outcomes. Where companies are failing to achieve outcomes that are profitable for the companies, but also for their consumers and people who are their broad stakeholders, capital departs those areas. It goes to areas where there is more opportunity both to be profitable but also to meet the needs of stakeholders, consumers and others.

Our belief is that the capital markets are going to find a way to solve a lot of the issues. I think that's a really positive message. The more companies are able to find different and better ways of supporting the world in addressing the climate challenge, the more interested people are going to be in finding a home for their capital in these kinds of enterprises.

There'll be companies that don't even exist today but in 10 years will be doing amazing things for the climate and the planet, and solving some of the challenges that we have now. And capital will be piling into these companies. For us, that optimistic view of the role of capitalism is a really important one, and I think it's a much better story for people than the negative view that the world is facing extinction. And if you have got an open mind and you know managers are looking to find companies that are doing better things, then that’s just a virtuous circle.

¹Aboriginal heritage site in the Hamersley Range in the Pilbara region of Western Australia.
²High commitment environmental investing.
³Impact investments are those that produce measurable environmental or social returns alongside financial returns.
⁴Impact reporting clearly communicates what management has achieved.

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The views expressed are the views of Andrew Marchant, Minchin Moore through the period ended 15 July 2022, and are subject to change based on market and other conditions.

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.

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