This year’s top 10 stories included a peek into AustralianSuper’s international equities build out in London, AMP’s move to slash employee benefits, and plenty of hard-hitting analysis of the issues that matter in institutional investment. But the real story is how readers helped shape all of that coverage.
Orbis’ Stuart Place is riding from Melbourne to the Moon and Back to fund a treatment for the “monster of a disease” that his youngest son was born with. The investment industry is rallying behind him.
‘They’re still sticking to their goals’: MSCI on YFYS
A micro-debate occasionally rages in the Australian financial landscape about whether we’re behind or ahead of the ESG curve. Certainly we’ve lagged Europe in terms of regulation, though the country’s asset owners have picked up some of the slack. But the real test is perhaps one of commitment; whether they stick with sustainable investing when the return environment isn’t as breezy as it has been over the last few years. The current market volatility has delivered that test.
“It’s been somewhat different in the Australia/New Zealand market versus what we’ve heard elsewhere,” says Dr Oleg Ruban, director of research at MSCI. “… Overseas, certain large investors did express privately and publicly the fact that they’ll slow down their decarbonisation journey given the concerns about energy security and the geopolitical environment. Here in Australia, we haven’t heard that from anybody – they’re all still sticking with their goals.”
“In Australia, you go to the next step; you say you’ve made these commitments and want to stick to these commitments. Ideally, you want returns and don’t want to sacrifice those returns, but it’s more about managing to the commitment as well as the return.”
Decarbonising equities is easier due to the amount of data available and gives asset owners “the biggest bank for their buck” when they comprise the largest chunk of a balanced option. But Australian funds are also leading on the decarbonisation of other assets. Some internal private assets teams have taken the lead here, starting with the “hardest bit first” in a move that Ruban “hasn’t seen outside of Australia”, speaking to pockets of “extreme sophistication” in the market.
But extreme sophistication or no, they’re still constrained on some facets of their ESG or sustainability goals by exogenous concerns: the shackles of the YFYS performance test. MSCI has been called in by several asset owners to help them decarbonise their portfolios with reference to the benchmarks.
“On the one hand members want exclusions – there could be a situation where it’s seen as sending a public message – and on the other hand, when you need to have your portfolio relatively close to the legislated benchmark, and having something that gives you that bump up in tracking error is difficult, because then you need to do a lot of things to bring it back,” Ruban said.
“You tend to start with risk mitigation – either you go the exclusionary approach, or you go with something a little more sophisticated. You take an optimiser, and you say you want to reduce the carbon intensity of your portfolio, but at the same time get the biggest bang for my buck in terms of that reduction for the least amount of tracking error.”
Other asset owners go further along the spectrum: sponsoring the transition and looking at green opportunities in a “holistic approach”; choosing indices that reweigh the portfolio in accordance with carbon transition scores; or an optimised Paris-aligned approach to meet “quite a number of different objectives”. Ironically, difficulties arise when they start playing around with portfolio optimisation tools to see how far they can get, taking on a multitude of goals that might conflict with each other.
“People want to do a lot of things at once,” Ruban says. “They’ll say they like Paris-aligned, especially if they’re not benchmark constrained, but then ask if they can also get a pickup in ESG scores. Can we get an alignment with the SDGs? Can we ensure that it’s country neutral, sector neutral, factor neutral? You have this bucket of different things that can conflict with each other.”
“One objective might conflict with another, so you need to wind up somewhere on the curve of the trade-off between the two. You might need to decide what your key priorities are – that should be a relatively constrained list – but then there are things that are nice to have.”
But the APRA benchmarks contain other idiosyncrasies. Due to the fact that there’s no benchmark for emerging market equities (they instead fall under global equities, pegged to the MSCI ACWI ex Australia) they’re already “an off-benchmark bet” – and so potentially easier to decarbonise.
“If you’re comfortable with having an emerging market allocation, it actually, in a way, can be an easier transition to go from a market cap benchmark in emerging markets to something carbon aware,” Ruban said. “If you look at it in terms of the tracking error to ACWI ex-Australia, it might not be too different. So in that segment you can make bolder bets. In other situations, we’re being asked to redesign higher tracking error indices in line with a tighter tracking error bound.”
Another micro-debate rages around whether the YFYS performance test has merely had the effect of amplifying the competitive dynamics and peer comparisons that ruled the industry prior to it – a formalisation of an informal “test” (albeit with a bigger sting). Certainly, overseas asset owners have had to justify their own investment decisions to stakeholders who have grown concerned about returns.
“I had a client say to me “Everybody is a long-term investor until you have a drawdown.” And then they start asking why that happened and what could have been done to mitigate it,” Ruban says. “You try to explain to your stakeholders that those are necessary for long-term performance, but at the end of the day you still get a lot of questions.”
“Here it’s formalised, but elsewhere you’ll still get similar pressures if you’re underperforming your benchmark or your reference portfolio or your peers.”
