Responsible investing

2 Responsible Investment

2.1 What is Responsible Investment?

Responsible Investment (RI) is a commonly used term to describe the practice of incorporating ESG considerations into the research, analysis, and selection of investments, and the implementation of good stewardship practices.

The MSL Investment Team (Investment Team) believes the key pillars of RI to be:

1.  ESG Integration – Systematic and explicit identification and consideration of material ESG issues in the investment decision-making process to improve investment outcomes (see section 3.2); and
2. Active Stewardship – exercising ownership and/or other rights that are conveyed through securities (or financial instruments), such as proxy voting, and engaging with the issuing companies to improve investment outcomes (see section 3.3).

ESG Integration contributes to improved risk-adjusted returns for investors. Active Stewardship that supports good governance practices and acts to ensure companies appropriately consider material ESG issues should contribute to the long-term sustainability and valuation of investments. Together, ESG Integration and Active Stewardship contributes to more attractive risk-adjusted returns for investors.

ESG issues and sustainability are defined in section 2.2.

This policy does not determine the investment universe of the IM. If the IM defines or limits the investment universe at the request of a client and as reflected in Investment Management Agreements or other appropriate documentation such as Product Disclosure Statements, the implementation of this will be detailed in additional product-specific documents such as the MSL Negative Screening SOP.

Various other investment approaches are also considered to be consistent with and complementary to RI but are not necessarily addressed by this Policy, as follows:

• ‘Socially responsible’ or ’ethical’ investing which may emphasise moral or ethical considerations and values over other information that may be relevant to investment outcomes;
• ‘Sustainable investing’ which explicitly targets companies that have a measurable and specific benefit on society such as being aligned to one of the United Nations Sustainable Development Goals (SDGs);
• ‘Negative screening’, or excluding particular companies from an investment universe because of their particular business activity e.g. tobacco producers;
• ‘Positive screening’ or ‘thematic’ investing which limits an investment universe to companies that undertake a specific activity e.g. renewable energy-related companies; and
• ‘Impact’ investing which explicitly acknowledges that investment returns are made up of both financial returns and measurable societal benefits, representing an investment outcome that would be not achievable in the absence of the long-term commitment of investors capital (known as additionality).

If the IM implements any of these additional approaches at the request of a client and as reflected in Investment Management Agreements or other appropriate documentation such as Product Disclosure Statements, the implementation of these will be detailed in additional product-specific documents such as the MSL Negative Screening SOP.

2.2 ESG & Sustainability Issues

There are a broad range of ESG issues that may of themselves, or in combination, impact the risk profile and return characteristics of an investment. The following table shows some examples of areas covered by (but not limited to) the broad headings of Environment, Social and Governance:

Sustainability issues are a broad range of issues that impact a company’s ability to generate long-term shareholder value. These issues include, but are not limited to:

• Management as stewards of capital;
• The industry within which capital is being stewarded;
• Financial and physical capital (financial and manufactured assets on balance sheet); and
• Non-financial capital (intangible forms of capital often not reflected on balance sheet such as human capital, social and relationship capital, natural capital, intellectual capital).

The consideration of ESG and sustainability issues in an investment context is evolving. It is expected that issues in addition to those covered above will be recognized over time.

3. Our Approach to Responsible Investment

3.1 ESG Beliefs & Key Principles

As an investment manager, MSL’s primary purpose is to design portfolios that aim to meet client goals with the most attractive return for the risk taken. The Investment Team primarily implements clients’ portfolios using specialist investment managers within each asset class. This informs how MSL approaches ESG issues in that a key aspect of the approach is assessing the ESG policies and processes of the investment managers.

The Investment Team’s key beliefs are:

• Integrating ESG issues into the investment process helps to manage risks and identify opportunities for our investors. Consideration of these issues needs to be an integral aspect of any investment process. Failing to consider material ESG issues means being oblivious to important business and investment risks.
• Given the goal of optimising investment outcomes for our clients it is important to recognise that sometimes ESG issues within a company can be under and overpriced by the equity market. The job of MSL’s active specialist investment managers is to understand the risks, taking them where they are well compensated and avoiding them when they are not.
• Actively and effectively engaging with companies – whether directly or via MSL’s specialist investment managers – to ensure they are appropriately managing ESG issues (along with all business issues) can reduce risk and improve performance over the long term.

In addition to and consistent with the above beliefs, the Investment Team adheres to the following three principles, each of which is aligned with the Principles for Responsible Investment (PRI):

• Principle 1: We will incorporate material ESG issues into investment analysis and decision-making processes.
• Principle 2: We will be active owners and incorporate material ESG issues into our ownership policies and practices.
• Principle 3: We will seek appropriate disclosure on material ESG issues by the entities in which we invest.

3.2 ESG Integration

ESG Integration is the systematic and explicit identification and consideration of material ESG issues in the investment decision-making process to improve investment outcomes. How this is incorporated into an investment process is often dependant on the asset class of securities under consideration.

MSL’s approach to ESG Integration only applies to the specialist investment managers with which it enters into investment management agreements (or equivalent). When assessing, selecting and monitoring investment managers, the Investment Team undertakes a formal assessment of investment managers approach to ESG Integration and actively encourages these investment managers to employ and enhance, where appropriate, their ESG integration practices.

The key aspects of the initial and ongoing assessment are as follows (but not limited to):

A.    Manager research:

• An integral part of our approach for evaluating specialist investment managers is to understand how they identify opportunities and manage risk. ESG integration is an important aspect of this and we focus on how it is embedded within their investment process.
• If the approach to ESG is considered inadequate, we will not appoint an investment manager.

B.    Ongoing monitoring:

• We review our managers’ ESG management processes as part of our regular due diligence process.
• In addition to regular meetings, we require each manager to provide a quarterly report detailing their approach to ESG integration and their activities and outcomes in relation to active ownership and engagement. This is designed to track how their processes are evolving, ensure the reality is aligned with the espoused approach (e.g. uncover greenwashing), and explore examples of where ESG risks have been identified, manifested or avoided.
• We undertake an annual review of each manager’s ESG policy and the incorporation of ESG risk factors into their processes.
• If we no longer consider the approach of a manager to the assessment of ESG risk appropriate, this can be a contributing factor to their termination.

MSL does not incorporate ESG considerations when undertaking any direct investments in any asset classes. 

3.3 Active Stewardship

Active Stewardship describes the systematic exercising of ownership and/or other rights that are conveyed by the ownership of listed equities (and related derivatives) and fixed-income securities such as proxy voting when applicable, and engagement with the issuing companies to improve investment outcomes.

3.3.1 Proxy Voting

Shareholder voting is a means by which shareholders can influence a company's operations, its corporate governance and activities of social responsibility. Proxy voting is where a vote is cast on behalf of a shareholder.

MSL works closely with MLCI, the Responsible Entity that determines how proxy voting is conducted for our portfolios. The process is designed to protect and enhance the investment value of our portfolios’ share investments, recognising the strong link between good corporate governance and investment value. MLCI applies the Financial Service Council (FSC) Standard and Guidelines on proxy voting to its operational processes where applicable.

MLC Investment’s Proxy Voting Policy can be found on mlc.com.au.¹

3.3.2 Corporate Engagement

The Investment Team’s view is that effective engagement with companies can lead to better long-term outcomes for shareholders. This can derive from requiring high standards of transparency, corporate governance, business strategy and social responsibility from the companies in which we invest via our managers.

MSL endeavours to be an active owner. In most situations, we believe our specialist investment managers, who ultimately choose which investments to buy, are best placed to engage with company boards and management on an ongoing basis. Hence corporate engagement for the most part is delegated to our managers, who are encouraged to engage with relevant companies on material ESG issues. In certain situations, the Investment Team may also engage directly with companies.

3.4 Complementary Approaches to RI

Section 2.1 details various other investment approaches which are considered to be consistent with and complementary to RI. Where MSL additionally addresses these approaches for specific clients, these are detailed as follows.

3.4.1 Negative Screens

The Investment Team believes that the effectiveness of negative screens needs to be considered very carefully. This is because divesting from or excluding companies:

• Can reduce the ability to engage and influence companies’ corporate behaviour for the better, and so inhibit the enhancement of long-term financial and societal outcomes;
• Means that the negatively screened securities cannot be bought, regardless of their price i.e. even if the negative ESG downside risks are more than priced in; and
• Reduces diversification – although as long as the excluded companies remain a small proportion of the investment universe, this is likely to be immaterial.

At the same time, we recognise that there can be occasions when a negative screen is appropriate – for example, to reflect a client’s explicit preferences and in situations where engagement is unlikely to have any impact.

Absent an explicit client preference, our framework for assessing the merits of screening out an entire sector or cohort of stocks focuses on the following questions:

• Does the Investment Team have a strong view and understanding that the adverse ESG risks in a sector are not priced in, and will continue to not be priced in?
• Will negative screening reduce MSL’s ability – usually via our specialist managers – to engage with the management of these companies to enhance long-term value?
• Does negative screening adversely impact the diversification characteristics of the portfolio or is it relatively immaterial?
• Are there risks from not negatively screening a sector – from a social license, member concern, or peer norm perspective – that could adversely impact the financial best interests of clients?

Where MSL implements negative screens at the request of a client (and as reflected in Investment Management Agreements or other appropriate documentation such as Product Disclosure Statements), the implementation of these will be detailed in the MSL Negative Screening Standard Operational Policy.

4 Position on Climate Change, Modern Slavery & Controversial Holdings

Consistent with the IFL Responsible Investment Beliefs (appendix 1), the IM also specifically recognises the importance of Climate Change and Modern Slavery as having financial implications for companies and therefore long-term investment returns. The following position statements, which may contain aspirational commitments, will be reviewed and developed annually as best practice evolves and in line with the IFL Corporate ESG Strategy.

4.1 Climate Change

Within our Policy, climate change is considered as part of the ‘E’ for environmental risks. Given it represents a material risk for the entire portfolio, and is a critical issue for society, we believe it justifies explicit recognition.

We recognise the science regarding the reality of climate change. We also recognise and support the global shift to targeting net zero emissions by 2050 in support of the Paris Agreement. These factors are likely to lead to significant investment impacts via:

• Regulation and government policy;
• Technology changes that will disrupt existing businesses and create new industries;
• Physical climate risks that will impact different regions in different ways;
• Changes in consumer behaviours and societal expectations of companies; and
• Measurement to enable the tracking and management of carbon emissions.

At a high level, we approach climate change risk from two perspectives.

Firstly, from a manager research perspective, we incorporate this risk into our broader ESG risk assessment. Given its importance, we include an explicit climate change section in the regular reporting we require from our underlying managers. We expect our managers to analyse these risks proactively and engage with companies on aligning their emissions with the targets established in the Paris Agreement. We also assess how managers are analysing climate change risks as part of our ongoing interactions and assessment of their capabilities.

Secondly, from an asset allocation perspective, we consider how different types of assets could be impacted in various climate change scenarios. This incorporates an assessment of how climate change risk may differ between regions and markets. For example, we may attach a higher risk premium to regions with a higher exposure to carbon-intensive industries to reflect the increased climate change risk.

Climate change is a rapidly developing field in terms of both the science and community expectations and we will continually evolve our approach to managing this risk.

4.2 Modern Slavery

Within our Policy, modern slavery is considered as part of the ‘S’ for social risks. However, given it represents an important risk for the entire portfolio, both from an investment and regulatory point of view, we believe it justifies explicit acknowledgment.

Modern slavery describes situations where offenders use coercion, threats or deception to exploit victims and undermine their freedom. Practices that constitute modern slavery can include human trafficking, slavery, servitude, forced labour, debt bondage, forced marriage and child labour.

Modern slavery can occur in every country, industry and sector and as global investors we need to understand, at a minimum, the impacts of these practices on the companies that we invest in. We approach investment risks arising from modern slavery in a similar way to other ESG investment risks, that is, through manager research and ongoing monitoring (as detailed in section 3.2). This includes:

• Explicit reporting from our managers on how they are assessing modern slavery risks in companies they invest in; and
• Monitoring the proportion of our assets that are allocated to countries and sectors that are considered at higher risk of modern slavery.

Modern slavery can also give rise to regulatory risks, mainly in the form of the obligations contained with the Modern Slavery Act 2018 (Cth). This Act requires MSL to report annually on the risks of modern slavery in their operations and supply chains (for MSL, that is the underlying investment managers that it allocates funds to) and actions to address those risks.

4.3  Controversial Holdings

Controversial holdings are those companies or industries that have negative ESG characteristics that represent long-term risk to performance, and these long-term risks can’t be mitigated by ESG integration or active ownership.

This Policy recognises there are a range of views with respect to controversial holdings such as gambling, alcohol, tobacco and weapons.

MSL requires external managers to use a combination of active engagement with companies to effect change and, to have strong investment thesis on these types of investments.

Where particular companies or industries are assessed to have negative ESG qualities representing long-term risk to performance and these ESG issues cannot be mitigated via RI or the additional complementary investment approaches, MSL may resolve to exclude such companies or industries from certain asset classes.

MSL has applied a listed tobacco manufacturing company exclusion.

¹ https://www.mlc.com.au/personal/nav_top/about-mlc/about-super-investments/proxy-voting