A growing number of Australian investors are taking a responsible approach to their investing, quite possibly without even realising they’re doing so. That’s the reality of a rapidly evolving global investment universe, in which more and more investment products are being designed around very specific responsible investing criteria. Added to that is the fact that investment fund managers worldwide are increasingly engaging with the companies that they’re investing in, on multiple levels, ultimately to drive long term-value creation for their end-investor clients. According to the Responsible Investment Association Australasia (RIAA), Australia’s responsible investment market reached $1.54 trillion in 2021, up from $1.28 trillion the year before. This represented 43 per cent of the $3.60 trillion that’s invested into the Australian managed funds sector. To put that another way, almost half of all the money that’s invested by Australians via an investment fund manager is being invested responsibly.

Understanding responsible investment

What exactly does responsible investment mean? Responsible investment, also known as sustainable or ethical investment, is a broad-based approach to investing which factors in people, society and the environment, along with financial performance, when making and managing investments. Vanguard’s responsible investment approach integrates environmental, social and governance (ESG) factors into one or multiple parts of our investment process and our product design. The environmental aspect of ESG investing relates to how companies and industries manage their impact on the environment. This could include climate change, deforestation, pollution and waste management. Social covers how companies and industries manage their impact on society, including their treatment of employees and suppliers, their community engagement, and their focus on health and safety. Governance revolves around whether a company employs good governance practices, such as having gender diversity on its board and leadership team, and appropriate executive remuneration. Five broad ESG categorisations, described below, are a useful starting point for investors to understand the variety of approaches taken by asset managers.

Exclusionary portfolio screening

Excludes companies based on their products or business activities (e.g. tobacco and fossil fuels) that conflict with certain values.

Inclusionary portfolio screening

Invests in companies or sectors considered to be more effective in the management of ESG risks, including those demonstrating meaningful improvement in the management of those risks.

ESG integration

Systematic inclusion of material ESG information in investment analysis and decision making.

Impact investing

Targeted investments with the dual objective of generating financial return in addition to positive ESG-related impact.

Stewardship

The responsible use of proxy voting and engagement activities by institutional investors to maximise overall long-term value.

Weighing up ESG investment performance

A common question asked by many investors is whether there’s a trade-off between ESG considerations (investing responsibly) and investment returns? The weight of market evidence shows that ESG-focused products have largely moved in line with broader markets over the longer term, although it’s also evident they can outperform or underperform over shorter time periods. For example, the recent global surges in energy prices has seen many ESG products underperform the broader market because they typically exclude listed oil and gas producers and supporting businesses. Overall, however, ESG index fund products are designed to behave like the broader market and still provide a diversified, low-cost exposure to a large number of companies while avoiding certain ESG risks. ESG risks and opportunities should be considered in the context of delivering long-term value and helping investors to meet their investment objectives.