Approach to responsible investment

We believe climate-related risks can have as meaningful an impact on company financials, company returns on capital, and enterprise value as other financial and non-financial risks.  In addition to this, as active investors, we can contribute through our investment activities to accelerate the transition to a low carbon economy. It is for these reasons that consideration of climate-related risks is a key part of our investment strategy.

The movement towards becoming a decarbonised society continues to be accelerated by various regulatory and policy changes creating a form of transition risk that needs to be factored into our stock analysis. Transition risk is likely to materialise in the medium to long term and requires the team to ensure that companies within the portfolio have robust sustainable business models or otherwise face the risk that company products, services or assets will be made obsolete. Energy and Material constituents are particularly susceptible to this form of risk as consumer demand and preference shift away from fossil fuels such as coal, oil and gas to cleaner renewables or in the case of miners, diversified alternatives/commodities. However, the transition provides growing investment opportunities in clean tech innovation and renewable energy.

Over time, companies unable or unwilling to embrace changes are likely to face reputational risk as investors adopt greater responsibility for their chosen investments and potential legal risk if they do not comply with current legislation. This has already started to occur across a number of companies in the Utilities sector, where consumer perception has deteriorated and demand slowed for companies continuing to use brown assets1 and those that are not demonstrating progress towards reducing carbon emissions.

Another key climate change risk is the physicality of global warming which manifests through extreme weather events such as floods and droughts. Predictability of the timing and severity of these events is typically low as they are likely to materialise unexpectedly. The physical risks posed by climate change have the ability to affect a broad range of industries such as Consumer Staples, where damage to physical assets, agriculture and produce can disrupt supply. Extreme weather events can also trigger large losses and claims for insurers and other financial constituents.

1Brown assets are assets that are dependent on fossil fuels or that are highly carbon intensive.

Our long-term investment horizon and focus on quality, growth companies fundamentally requires sustainability in business models and practices and is inherently well suited to strong ESG outcomes. Our framework consists of several tools and risk assessment processes which have been established to help the Australian Equities Growth team analyse and identify the sources of ESG and climate change risks in the portfolios. These include: the team’s proprietary ESG scoring system and the Carbon Dashboard report.

The starting point for our climate-related risk assessment is the Australian Equities Growth team’s proprietary Environmental, Social and Governance scoring system. The scoring system is an internally developed tool that draws on both our analysts’ experience and expertise as well as best-in-class quantitative data. Each of E, S and G are scored (with analyst input and external data weighted 50 / 50) for all of the companies under our coverage, with the final score allowing us to compare stocks across industries and sectors. The scoring system utilises climate-related data from Sustainalytics, MSCI and ISS to identify climate change risks, such as carbon footprint, emissions intensity and exposure to fossil fuels. These inputs and resulting scores help the analysts and portfolio managers to identify the risk exposures for each company and are factored into model forecasts, Discounted Cash Flow (DCF) valuations and stock recommendations.

The firm wide Carbon Dashboard provides an overview of the team’s carbon footprint, emissions and intensity profile against its benchmark - highlighting at the portfolio-level, the sectors and companies that are contributing positively/negatively to the portfolio's carbon emissions. The capture of factual data better equips our analysts and portfolio managers to discuss how prepared a company is to transition to a low carbon economy, and the likely impacts of such a transition on the company. 

The team use ISS DataDesk to run carbon and transition risk scenarios and run quantitative screens on scope 1 and 2 emissions2 for potential carbon tax adjustments. The combination of these two tools feed into the analyst’s research and aid in the recognition of climate-related risks.

2Scope 1 refers to greenhouse gas emissions that are directly caused by a company’s operations. On the other hand, Scope 2 emissions are indirectly caused by the company through their consumption of purchased energy.

The Australian Equities Growth team integrates climate-related risks and opportunities into their investment process through their proprietary ESG scoring system. Excluding only the firm-wide commitments such as controversial weapons and tobacco, the team firmly believes that ownership and engagement for change is more effective and more value- adding for clients than negative screens.

Analysts are responsible for monitoring which companies have committed to net zero targets and whether their emissions are reducing over time. By doing so, we are able to cross-reference these targets with the Environment scores allocated to each company as part of our ESG scoring system, in turn influencing the stock recommendations made by our analysts (Strong Buy / Buy / Hold / Sell / Strong Sell). Our ESG analysis and rating system can and does impact potential portfolio weights particularly if risks become more material. Decisions, which are made on a case-by-case basis, can result in higher or lower portfolio weight than would otherwise be the case or, in material instances, a complete exit/entry of a stock.

Key performance indicators used to track the portfolio’s progress include level of carbon intensity and the 3 year change feeding from the team’s scoring system. Carbon intensity is tracked at both the portfolio and company level through the use of the Carbon Dashboard, ISS DataDesk and the team’s ESG scoring system. Companies that are not demonstrating improvement are subsequently penalised in the scoring system and will result in further ongoing engagement and monitoring by the team.

By maintaining an open mind, we retain the ability to address potential risks by engaging with all stocks – with the aim of participating in collaborative discussions with management and the board to influence continuous improvement over time. Thus, in light of the uncovering of climate-related issues we engage with the board and senior management of the company as we try to gain comfort that the company is aware of, and accountable for, the management of material issues. Material issues that are not being appropriately addressed can be escalated through our proxy voting, investment decisions and ultimately divestment.

Our active approach to voting allows us to individually assess the merits of, and submit votes for all proposals. In light of any climate-related issues, our assessment of proposals is based on our analyst’s expert knowledge of the company and additional insight offered through both CGI Glass Lewis and Ownership Matters. We utilise the research capabilities of two separate proxy advisers to ensure diversity of thought. When voting against the management or proxy adviser recommendation, the analysts are required to submit supporting comments that rationalise and explain their voting decision, which allows the team to keep track of the issue.

A series of portfolio targets have been established by the Australian Equities Growth team.

Our assessment framework is based on the net zero alignment maturity scale contained in the Institutional Investors Group on Climate Change’s (IIGCC) Paris Aligned Investment Initiative framework but is tailored to the Australian Equities Growth team to reflect our expectations of companies as they transition.

By the end of 2025, the Australian Equities Growth team commits to progressing towards the following short term targets using this framework:

• At least 40% of FUM is invested in companies that are ‘Aligning to net zero’
• All companies owned by the Australian Equities Growth team that are in a high impact sector as defined by the IIGCC framework have an ambition to decarbonise their business.

Between 2025 and 2030, the Australian Equities Growth team commits to progressing towards the following medium term targets using this framework:

• At least 50% of FUM is invested in companies that are ‘Aligning to net zero’.

Long term targets include:

• All companies owned by the Australian Equities Growth team are ‘Aligning to net zero’ by the end of 2040
• All companies owned by the Australian Equities Growth team produce net zero emissions by the end of 2050.

The team believes that climate-related engagement is more likely to stipulate better outcomes for the business and our clients in comparison to making portfolio exclusions. We acknowledge that not all companies are on the same stage in their net zero journey and by using portfolio-level targets we can own, engage and push for positive change in new and growing companies as well as larger, more established businesses. Similarly, our stock-level ESG scoring and analysis enables us to identify industries and companies that are high carbon emitters, which provides the opportunity for the team to prioritise engagement within these high impact sectors.

As part of these transition targets and our continued engagement with companies, we expect there will be natural progression to green assets and subsequent steady reduction of brown assets over time.

For more details on how the terms 'Net Zero', 'Aligned', 'Aligning' and 'Committed to Aligning' are defined, please read Our climate metrics and target. These definitions follow the guidance from the IIGCC’s Net Zero Investor Framework.

These targets have been formulated based on: (i) available information and representations made to First Sentier Investors by third parties, including, but not limited to, portfolio companies; and (ii) assumptions made in relation to future matters such as the implementation of government policy in climate-related areas, enhanced future technology and the actions of portfolio companies. Such information and representations may ultimately prove to be inaccurate and such future matters may not ultimately be realised. As such, First Sentier Investors cannot guarantee the achievement of these targets. These targets are subject to ongoing review and may change without notice.