Under the Hood of ESG Investing

Abstract

We conducted a series of 26 interviews with Australian institutional investors in 2021-22, including asset owners, asset managers and advisory firms. Findings:

1. The key driver of the use of ESG information by these institutional investors is its materiality for investment performance. ESG information is particularly relevant for managing portfolio risk.

2. Other drivers of the use of ESG information are regulator and client demand for ESG. Both regulators’ and clients’ agendas go beyond just financial considerations.

3. Research participants use ESG information primarily for engagement with investee companies. That is, these institutional investors tend to be ‘active owners’, focused on changing the practices of companies rather than excluding them from their portfolios. Australia is described as an engagement utopia due to the scale of large super funds and their ability to coordinate their engagement efforts.

4. Institutional investors in our sample are concerned about greenwashing by both firms and fund managers and take extensive action to tackle it. Company engagement is a crucial element in better understanding management practices and culture.

5. The ESG investing practices we observed suggest that for at least some Australian institutional investors, ESG commitments are authentic and go beyond superficial claims. This is heartening for the general public who may be sceptical about ESG investment vehicles.

6. The culture of investee companies is a vital consideration for our institutional investors. Company engagement is the most frequently mentioned method for assessing it, confirming the perceived importance of engagement in the investment process.

Keywords: ESG, institutional investors, active ownership, greenwashing

JEL Classification: G11, G23, Q50