By Susan Chenoweth

In recent years, charity, not-for-profit (NFP) and philanthropic fiduciaries have started looking at how their investments can be better aligned with their missions.

Is it possible? Yes.

Is it tricky? Yes, it can be.

Many NFPs are actively integrating environmental, social and governance (ESG) factors into their portfolios. Despite the apparent alignment with not-for-profits because of their purpose-driven missions, this can pose significant strategic and tactical challenges.

This paper seeks to help for-purpose investors to better understand the opportunities and challenges associated with harnessing their capital for good, especially when ESG means different things to different stakeholders.

What exactly is ESG?

“ESG” is sometimes seen as a reference to being green. But it encompasses much more than that.

The ESG abbreviation stands for “environmental, social, and governance.”

These three terms are broad categories that encompass a wide range of criteria that can be used to assess a company and determine whether an investor should invest or divest of shares in that company.

Environmental factors could include the company’s overall carbon footprint or how it handles waste or pollution.

Social factors may relate to the company’s employment policies, charitable contributions, or community involvement.

Governance criteria may also consider board diversity, and wage disparities. (Investopedia, 2022).

So, the ESG framework is more than a green screen. It’s broad and deep to ensure that entities are assessed thoroughly. If a company is judged to be doing well in one area, but not so well in others, its overall score will be affected.

The $1.3 trillion shift to responsible investing

According to the latest report by the Responsible Investment Association Australasia (RIAA), $1.3 trillion of assets are invested responsibly in Australia.

This amounts to about 36% of all professionally managed funds, indicating a significant shift towards responsible investing.¹ Moreover, it is predicted that ESG investing will become a standard practice for most retail investors in the coming decade.

While there is a lack of Australian data on what proportion of investments made by charities, not for profits and philanthropic foundations are invested according to ESG criteria, there is little doubt it is on the rise.

Some of the most recognisable names in Australian philanthropy, including the Myer Foundation and the Besen Family Foundation, have announced 100% of their multi-million-dollar portfolios will be re-directed to responsible investments over time.²

According to Mercer’s 2022 not-for-profit survey, 83% of such organisations worldwide are either already incorporating ESG into their investment decisions or planning to do so in the coming year.

How and why endowments might pursue ESG investing strategies?

Grants are not the only way to make an impact

Foundations have historically separated their grant-making function from their investment function. However, these two aspects of foundation management are increasingly being brought together, in an effort to create greater impact.

By investing in companies that align with their mission and objectives, they can contribute to their goals in multiple ways.

To align investments with their philanthropic mission, organisations often begin by avoiding companies that present ESG-related risks. The specific criteria for such screening will vary depending on each organisation’s unique mission and purpose.

For instance, Elston’s for-purpose clients frequently exclude investments in mining, or companies presenting environmental risks, but other organisations may prioritize different risk factors.

When Anne talked to us about how she wanted her Private Ancillary Fund’s investment strategy to align with its mission, our asset management team was keen to help.

After a number of meetings and discussions, the parameters of our ‘no harm’ approach were agreed. No investments were to be made in a corporation where the principal activities concerned gambling or tobacco. The trustees also wanted to avoid companies that contributed to anthropogenic climate change.

This was efficiently achieved through the Individually Managed Account structure by the placement of trading exclusions for companies with revenues derived from direct participation in the above activities. These exclusions can be changed at any time should the concerns shift direction.

Doing no harm is often where organisations start. But organisations may want to extend beyond this approach. They could decide to not just avoid investing in particular companies, but also to choose to invest in organisations that are actively doing good.

The Paul Ramsay Foundation (PRF) has allocated over $100 million of its considerable assets for impact investments aligned to its values and social purpose. They are seeking to generate measurable positive social outcomes in addition to a financial return that allows PRF to further support its partners.

“Unsurprisingly, for many purpose investors aligning investment selection to their mission and values is crucial, and they are proud to be integrating ESG factors into all their investment decisions. It’s important to them that they are true to their mission.”

– Susan Chenoweth

Meeting stakeholder expectations

Society has high expectations of organisations that provide a benefit for the greater community. There is a growing expectation from stakeholders including donors, partners and bequestors that the not-for-profits and foundations they support take a responsible and sustainable approach to their investments. This is particularly true when those investments have been generated from donated assets.

Public scrutiny, enhanced by both traditional and social media, makes non-profit organisations more visible. This, combined with the global shift toward responsible investment, means that potential donors expect their beneficiaries to invest donated monies responsibly, and they have the ability to monitor that.

Research has found that in the US, university endowment funds experience 6% higher donations following the adoption of socially responsible investment (SRI) policies, providing evidence that SRI policies can be associated with more successful fundraising flows.³

However, ESG considerations for these organisations are complex and not easily measured. Stakeholder expectations can be hard to gauge. An animal welfare charity is likely to avoid investing in companies that harm animals through the course of their operations. Should that same charity ensure their investments are screened for social and governance considerations? Should these investments be avoided at the expense of investment returns which then in turn impact the charity’s ability to generate income to spend on mission-related activities?

A materiality assessment can be a good start in navigating this complexity. Of all the possible areas of focus, what is most relevant to your stakeholders and what will have the greatest alignment to your mission?

For example, divestment of tobacco-producing companies might be an obvious choice for a health charity but less of a priority for an arts organisation. A strong investment governance framework with a well-defined strategy and clear ESG investment policies are crucial to ensure that investment decision-making is considered, defensible and transparent.

Enhancing risk-adjusted returns

Many see the integration of ESG issues in investment analysis and investment decisions as an important risk management procedure, knowing that these factors can affect investment performance. Therefore, private investors and for purpose organisations alike, will seek investment managers who integrate the analysis of ethical, social, and governance issues into their investment process.

Incorporating ESG assessment enhances our knowledge and understanding of a company’s management, culture and business strategy and enables us to make better informed investment decisions on behalf of our clients. We believe ESG issues can have a direct impact on the sustainability and profitability of a company, and their level of risk associated with investing in that company”.

– Bruce Williams

ESG investment practices still evolving

Standardisation across the industry will eventually bring consistency and transparency to all investors, however in the meantime there are challenges to implementing an ESG framework.

There are a diverse range of approaches to ESG investment practices, and very little existing legislation in Australia or internationally for regulating environmental, social and governance (ESG) investment standards .

In addition, there are a wide variety of metrics, methodologies and approaches to measuring ESG performance of different investment portfolios. The way that scoring is applied to some of the subjective ESG elements can be opaque. All of this gives rise to different interpretations of ESG performance and framework for industry consensus.

ESG data, metrics and calculations vary per provider and how this data is interpreted in the context of an investment decision can differ. Results may differ from portfolios that do not apply similar ESG considerations to their investment process.

In addition, the investment returns of ESG focused investment products have shown mixed results over the past decade, raising questions as to the true extent to which ESG drives performance.

Overall, this lack of comparability of ESG metrics, ratings, and investing approaches makes it difficult for investors to assess and compare ESG investment options. It’s also difficult to predict the financial returns that they might generate.

The need for better data on performance

We need a universal screening framework so all ESG evaluation is on the same basis. There is also a need for more widely agreed definitions and terms.

Given the non-standard nature of ESG disclosure, quantitative scoring is far from a complete picture and good policies don’t necessarily mean good implementation and practice.

Are some asset managers greenwashing?

ESG has always been somewhat controversial. Some companies and investment manager have been accused of “greenwashing”, and providing misleading or false information about their sustainability practices to attract investors or consumers.

It continues to be an issue. This month, The Australian Securities and Investments Commission (ASIC) announced that it has commenced civil penalty proceedings in the Federal Court against Active Super. The allegations relate to greenwashing, misleading conduct and making misrepresentations to the market, claiming that it was an ethical and responsible super fund.

This marks ASIC’s third greenwashing civil penalty proceeding following action taken against Vanguard in July and Mercer Super in February.

ESG measurements are easily manipulated.

Many critics focus on the quality of the ESG measurements themselves, pointing to examples where companies like ExxonMobil get rated higher than ones like Tesla (Taparia, 2021). The “greenwashing” critique fits here as well, noting how rating systems can be easily fooled by savvy corporations.

The limitations on the current ESG investment framework pose serious threats for the not for profit sector and philanthropic foundations. These will grow in intensity as more organisations take an ESG approach to their investments, in an effort to deploy their capital to achieve the greatest impact.

Impact on investment income and spending policies

During and since the global pandemic we have seen a sustained increase in the need for NFP services, as well as philanthropic funding to support them. This has resulted in increased spending requirements for “for purpose” investors. While these investors are transitioning to a greater ESG oriented portfolio, they are concerned that there is a trade-off between ethically aligned investment and financial returns. Lower returns ultimately mean less money for grant-making or charitable purpose, contradicting the supposed mission related investing. Not for profits will need to consider how these intersecting priorities will affect their spending policies and the risk/return profile of their investment policy framework.

Investment Governance Framework

ESG integration can be achieved in a variety of ways including manager selection, investing in thematic strategies, negative screens, impact strategies. A strong investment governance framework with a well-defined strategy and clear ESG investment policies are crucial to ensure that investment decision-making is considered, defensible and transparent.

Elston can help achieve all of this through its Investment Governance frameworks and guidance. We are experts and specialists in NFP and Philanthropic capital. For more information please contact us here.

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If you’d like to know more about Elston Philanthropic Services, contact Susan here.

References

1. Responsible Investment Association Australasia Benchmark Report 2023
2. Sidney Myer Fund & The Myer Foundation website
3. Socially Responsible Investments (Revised Version).pdf (yale.edu)
4. Do Company Ethics and Stakeholder Focus Equal Greater Long-Run Shareholder Profits? (torreyproject.org)