While the big four banks and AMP remain firmly in the sights of the royal commission, a larger conversation is taking place within the industry’s boardrooms.
Over recent years responsible investment principles have taken hold in the industry whereby investors expect investment managers to take into account environmental, social, governance (ESG) and ethical issues into consideration when selecting and monitoring investments within their portfolios. Regardless of the outcomes of the royal commission, ESG issues may force responsible investment managers to question their ownership of 21% of the ASX 200 Index, which represents the total index weightings of the banks and AMP combined.
The inclusion of ESG and responsible investment principles into an investment mandate has largely been driven by investors. The Responsible Investment Association Australia (RIAA) recently found that 92% of Australians expect their superannuation or other investments to be invested responsibly and ethically; and that 69% of Australians would rather invest in a responsible super fund that maximises financial returns while taking into consideration the environmental, social and governance issues of the companies it invests in, than one that only looks to maximise financial returns. The larger super funds such as HESTA, Australian Super, and REST, have been promoting these principles as a mandate requirement for their external investment managers. The issue is significant as the RIAA report found that nearly half of Australia’s assets under management are now being invested through some form of responsible investment strategy.
Corporate governance issues have traditionally centred on disclosure, executive pay, and board composition. Post the royal commission it could be suggested that a new benchmark has been set within the definition covered by corporate governance and ethical issues. By definition this should now include conflict of interests, misleading the corporate regulator, fees for no service, inadequate oversight and inactive customer remediation – all of which are obvious breaches and bring into question how responsible investment managers within Australia will respond. For example, if you own AMP in your equity portfolios, should the position be liquidated based on a failure by the company to uphold ESG principles? As a recent example, Betashares recently removed Facebook from its Global Sustainability Leaders ETF (ASX: ETHI) on the back of its recent serious data breach. If the principles of responsible investing are to be pursued, then a position, regardless of its index size, could be removed from a portfolio if governance issues have been breached. Unlike a custom designed ETF, removal of stocks from an equity portfolio for ESG reasons could pose significant issues with respect to performance.
As it represents only 0.78% of the ASX 200 Index, AMP may be an obvious target for an immediate and direct response by responsible investment managers. Selling this position may not have major index tracking implications for an investment mandate. A far more difficult decision will be for investment managers in relation to their bank holdings, as they represent 20% of the ASX200 Index. The question then for ESG mandated super funds is whether they really expect their investment managers to liquidate such a large part of the index? Only time will tell but it would be unlikely. Which is why AMP could be the obvious ESG casualty within a portfolio. The Royal Commission now represents an ESG test case and how a responsible investment manager responds will be reviewed by every superannuation fund and research house into the future.
I would hate to be a fund manager right now pitching for a superannuation mandate and being asked about their ESG response to the Royal Commission. How would they manage their portfolio under these circumstances? Whilst we eagerly anticipate further submissions from the big four and AMP, compliance teams, investment committees and lawyers will be reviewing every ESG mandate in the market. One thing is certain though: they would have never expected this sort of corporate behaviour when they created ESG principles and mandates.