Integrating environmental, social and governance risks and opportunities into the portfolio

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1 POSITION PAPER Integrating environmental, social and governance risks and opportunities into the portfolio Background Different investors take different approaches to managing environmental, social and governance (ESG) risks and opportunities in their investment programs. The breadth of approaches reflects the variety of the governance arrangements, objectives and investment strategies pursued by investors. It is also unsurprising that interest groups and members of the public have a range of views about how, or whether, to incorporate ESG matters into an investment program. The Future Fund s starting point is its mandated objective to maximise returns earned on the investment portfolio while appropriately managing risk. The Fund combines this with its belief that effective management of material financial and reputational risks and opportunities related to ESG issues will, over the long term, help it achieve its objective. This belief is built into the Fund s own investment decision-making, into the way in which the Fund manages ownership rights associated with investments and into its process for selecting the external investment managers responsible for individual investment decisions. In putting together its framework for managing ESG issues the Future Fund draws on its legislation and mandate, investment beliefs, investment strategy and international best practice to provide a prudent and robust approach that is aligned to the Fund s overall objective. The Fund applies its ESG beliefs through its investment strategy and its Environmental, Social and Governance Risk Management Policy which is published online 1. A first iteration of this approach was published in when the Future Fund first started its investment program - and it has since been extended and updated reflecting the organisation s evolution. ESG Risk Management Policy The Fund s ESG Risk Management Policy reflects the view that ESG integration is about investors and companies taking a longer-term view and understanding the full spectrum of future risks and opportunities to which assets are exposed. For the Future Fund this is delivered through three elements: Enhanced investment decision-making. Integrating ESG issues into investment decision-making at the portfolio strategy level, at the asset class strategy level, in the consideration of investment in individual assets and in the selection and monitoring of the external investment managers that the Fund uses to make investments. 1

2 Exercise of voting rights and engagement. Applying the Fund s rights as an owner, both directly and through its external investment managers, to support good governance and high standards of corporate behaviour. System improvement. Supporting best practice, the integrity of the financial system and development of new markets often through collaboration with other investors, market participants and regulators. The policy also provides a framework which helps the Fund determine what entities and sectors it excludes from its investment universe for non-financial reasons. While individuals often hold strong views on these questions, the Fund, as a long-term investor governed by an Act of Parliament, must ensure that it meets its obligations and avoids an ad hoc approach that would be at odds with its long-term horizon. The Fund has put in place a framework for exclusions that revolves around its legislation, mandate, the legality of the investment, consideration of international conventions or treaties ratified by Australia and the effectiveness of efforts to influence corporate governance and behaviour. The framework provides clear markers that help the Fund to consider issues that can often be complex and opaque, while being designed to support the overall objective of generating strong returns while managing risk and operating to international standards of best practice. 2

3 Implementation The Fund s ESG Risk Management Policy is applied in a variety of ways depending on the particular asset class and strategy. As an institution that operates through external investment managers, a large part of the policy s implementation is done through those external investment managers. These managers bring significant expertise, experience and resources to the Fund s investment program and ESG considerations. The Future Fund, however, is also directly involved in ESG Risk Management through the activities of its investment team, through its relationships with other institutional investors, research providers and industry bodies and through its direct engagement with investee companies on a range of issues. The following section, while not comprehensive, provides examples of how the policy is applied in practice. Investment decision-making Voting rights and engagement System improvement We consider the strategic themes that are likely to dominate outcomes for investors over the medium- to long-term. Demography, resource scarcity (including energy, water and food scarcity) and the political and regulatory responses to those issues are among the topics at the centre of our strategy. We integrate these perspectives alongside economic and market factors and build scenarios and assessments that we use to set and adjust the investment program. For relevant managers we seek to understand their approach to considering ESG risks in investment decisions. This may include, for example, exploring how the manager values a mining company s reserves, assesses the risks of political or regulatory change or considers social or environmental risks in a company s supply chain. In Australia we exercise the voting rights associated with our listed equity holdings ourselves based on our published voting principles and manager and adviser views. Our voting principles address issues of governance, board composition and skill, respect for shareholder rights, management of risks including environmental and social risks and performance evaluation and incentive systems. Offshore, our external managers exercise our rights on our behalf (after we have confirmed that their approach is consistent with our voting principles) but we retain the right to override manager decisions. Our external managers maintain extensive direct engagement with companies, while we also engage directly on ESG matters such as: board composition, executive remuneration, human rights, greenhouse gas emissions pricing and transparency in lobbying and regulatory engagement. As a large, global investor the Fund participates in and contributes to efforts to support stable, transparent and efficient financial markets and collaborates with other investors on systemic challenges related to ESG issues. The Fund participates in ESG discussions and initiatives through the Council of Institutional Investors, the International Corporate Governance Network and the Rotman International Centre for Pension Management and other initiatives. More broadly, the Fund helps to advance best practice through the Hedge Fund Standards Board, the Institutional Limited Partners Association, the International Forum of Sovereign Wealth Funds, the Pacific Pensions Institute and the Paul Woolley Centre for the Study of Capital Market Dysfunctionality.

4 Investment decision-making Voting rights and engagement System improvement When considering an investment in an asset such as building, a road or a port, we will often work alongside our managers to conduct due diligence on environmental and social risks drawing on expert research and analysis and integrating this into our investment decisionmaking. In private markets we exercise our voting rights, take up opportunities to participate on advisory boards and appoint directors to the boards of companies and other entities. This ensures that we have the opportunity to protect the interests of the Fund by exercising oversight over management. We have supported academic and industry research through the Funding Australia s Future project run by the Australian Centre for Financial Studies, In 2014 we are collaborating with the Centre for International Finance and Regulation on a series of research papers on the benefits and challenges of long-term investing. In addition to the above description of how the Fund implements its ESG Risk Management Policy, the Fund also applies its framework for considering exclusions from the portfolio. This is done by drawing on expert third party research and the Fund s own analysis. As a result of this work, the Fund has excluded entities from its portfolio in relation to the Convention on Cluster Munitions, the Anti-Personnel Mines Convention and the primary manufacture of complete tobacco products. A list of entities excluded under the ESG Risk Management policy is kept on the Fund s website data/assets/pdf_file/0011/5105/2013_june_excluded_companies_list_a pdf 4

5 Conclusion ESG Risk Management is widely acknowledged in the investment industry as an important part of operating a successful, properly managed investment portfolio. The Future Fund has had a commitment to ESG Risk Management since its inception and is an active participant in industry dialogue on this topic and the continued development of ESG good practice. It will always be the case that individuals and groups within the community will have differing views on particular investments and on the role of the Future Fund in considering important issues such as pollution, climate change, human rights, labour laws and corporate governance and their influence on the portfolio. While acknowledging others perspectives, the Future Fund has built a robust approach to managing ESG risks and opportunities based on its legislation, mandate, investment strategy and investment best practice and remains committed to implementing this approach in accordance with its long-term mandate. Will Hetherton Head of Public Affairs Ph: +61 (3) Mob: + 61 (0) June 2014