What’s meant by ESG?

ESG is environmental, social and corporate governance issues, and we’re interested in them and the extent to which they can help us make a better investment decision.

Why would you want to incorporate ESG issues into your investment strategy?

We see [it] as a way to give us a better insight, first into the quality of management of an organisation [and] second, into how a company is managing risk.

So an organisation that has a number of fatalities on site is clearly a poorly managed company. An organisation that’s inefficient and is using more water or energy per unit of production [than its peers] is clearly a poorly managed company.

An organisation that’s failing to mitigate long-term carbon risks or failing to demonstrate how it is securing long-term water supply for production processes is a company that’s potentially not managing risks as well as it could [or should] be.

Is the upcoming carbon tax a particular concern for listed companies?

Look, the carbon policy’s a really interesting one, because a number of Australian companies got quite a generous amount of their permits free in the early stages of the scheme. We have the price cap in the early years of the scheme as well.

So actually, the Emissions Trading Scheme isn’t something that has changed the way that we’re allocating capital in, say, the next three years … it’s not really going to have much of an impact.

What does good governance look like?

Governance is about having the right people on the board in the first instance. So we look for independence, and our definition isn’t in terms of the tick-the-box approach and not being associated with the companies or not working with an affiliated entity. It’s really about independence of mind as much as anything else, and having the right skill sets to be a director of the entity.

What about where you have a chairman who’s also the CEO?

We’ll vote against that, typically. We like to see separation of duties between the chairman and the chief executive.

Why is that?

Because you want the CEO to be challenged. Even the best chief executive that you invest in – and you often invest in a CEO, you chase quality of management – you still want them to be challenged. That’s the role of the chairman. That’s the role of the board, to really question management and to be that guide for management to be able to go to in order to test the strategy, to test the long-term vision and to ensure that there’s alignment with the long-term interests of shareholders, not just the executives trying to look after their own back pocket.

How can you tell whether an executive is being paid excessively?

It’s a really hard thing and, unfortunately, there is no rule of thumb in terms of what any one person’s worth. It’s really about looking for alignment. As long-term shareholders, we look for [rewards] based on long-term incentives, rather than just the short-term.

Like share options that vest after a period of years?

Not only shares; actual cash payments being based on performance over a three-year period, and we want to make sure that that’s averaged out. We like to see some “at risk” component of it as well. We prefer to see more options with the entrepreneurial-type companies, where you want to attract a type of executive that has that entrepreneurial spirit.

In some of the biggest companies, that sort of risk taking isn’t what you’re investing in. You’re investing in good managerial skills. So you want a different style of manager and an options package isn’t necessarily going to get you that type.

[So] it’s about having the right remuneration structure for the nature of the company, being longer term in focus and also just not having a quantum that’s completely out of the ballpark.

What are a couple of local examples of listed companies you score highly on ESG issues?

One of our favourite companies from a sustainability perspective is Wesfarmers (WES). Ten years ago, when I had my first conversation with them about carbon risk, they were the only company at that time we knew of that had actually done carbon risk forecasting for all the different aspects of their business and what it would actually mean for profitability, and from a risk perspective.

Another company – and it’s an interesting one – is Treasury Wine Estates (TWE). [In] Foster’s Group (FGL), wine was always seen as the poor second cousin, but we saw some really good work that was being done looking at the effect climate change would have on different grape varieties, and the environmental impact for the wine sector. There’s some good management of the risks within that wine trade. Being a separate business now, the company’s really been able to focus on those environmental issues and also has been able to find a culture [that’s] very much about entrepreneurialism and passion in selling the wine product.

What’s the next big thing?

You have to be thinking about a company’s skill set in managing sustainability issues in emerging markets. All investors should be considering whether an Australian company they plan to invest in [has some of its growth strategy] related to these markets. Take, for example, Newcrest Mining (NCM). It is great at managing community issues out in Orange, but it’s a completely different scenario dealing with stakeholder issues in PNG or the Ivory Coast. So NCM has been able to get the right people on board to steer those potential risks [here and abroad].

How can investors keep on top of any company-specific ESG issues related to Australian companies operating overseas?

Read the front section of the annual report and Google the company’s website address. It’s often the best source of the negative news on companies.