Max Cappetta, CEO, Redpoint Investment Management, discusses socially responsible investing (SRI) with Ross Kent, Global Head of Institutional Distribution, NAB Asset Management.
Ross Kent: Good afternoon. I'm Ross Kent and I'm responsible for the institutional client group at NAB Asset Management. With me this afternoon is Max Cappetta, the CEO of Redpoint Investment Management. Welcome, Max.
Max Cappetta: Thanks, Ross. Great to be here.
Ross Kent: Thank you. Max, Australian equity investors have been at the forefront of SRI, or ESG investing, for some time now. As an investor yourself, how do you, or what does it mean, rather, to be an SRI investor in Australia?
Max Cappetta: Yeah, thanks, Ross. Socially responsible investing is nothing new. Investors for, a long time, have used their investment capital to seek changes to the way that businesses operate, and avoid a lot of things that they see as distasteful or not essentially socially responsible in the way that their activities are run. Generally, socially responsible investing involves screening out and excluding investment in companies that are involved in activities such as the manufacture of armaments, tobacco, alcohol, involved in pornography, and in gambling. Very importantly, more recently, a lot of investors are focusing on the impacts of climate change, and looking to avoid companies that are involved in fossil fuel, both mining, and also in the emissions of greenhouse gases.
Ross Kent: So if you are simply excluding those stocks that have a significant exposure to those industries, what does that mean in terms of an Australian equity portfolio? How much might you be excluding, for example, of the index?
Max Cappetta: Yeah, so when we consider the ASX 200 benchmark as it is today, it's actually quite interesting for Australian equity portfolios. The fossil fuels exemption that you might want to screen out will, in fact, take approximately 15 percent of the market cap out of your investible universe. That's by virtue of the fact that the Australian market, as we know, has a reasonable concentration in that resources sector. In other words, companies that are involved in the extraction of coal and also petroleum that is oil and gas.
Ross Kent: Wow. 15 percent. So how do you go about reallocating that capital, for example, if you've been asked to exclude those stocks from your portfolio?
Max Cappetta: It's an important thing for investors to consider how they actually do that. If you take that capital away and then just naively re-weight it according to the market cap of the stocks you have left, you'll move from having one bias, to essentially having another, which means you're going to put most of that capital into four large banks. And that may not be really wellaligned, in terms of building a diversified Australian equity portfolio.
Ross Kent: So Redpoint's approach then to making sure that their capital remains diversified and balanced, in terms of the risks, how do you go about it?
Max Cappetta: There's a number of different insights that we think are important when you try and balance an SRI exclusion process, with also the objective of building a diversified Australian equity portfolio. There's a couple of things that we do that we believe are important and all investors should do as well. Firstly, it's identifying the sustainability characteristics of a portfolio of assets, and that is looking at the E, S and G, the environmental, social and governance practices of firms. That will lead you to avoid companies that are most at risk of poor practices in that space. Secondly, we believe that stock selection is important. When you need to redeploy such a large amount of assets into the rest of your portfolio, you need to have an understanding of valuation, and quality, and growth, and make sure that you apportion the assets that you've now got to redeploy, in the optimal way. And of course, tying all of that together is risk control, portfolio construction. That optimisation process is critical to make sure that you get the tradeoffs right.
Ross Kent: And Max, I'm imagining too then that that ongoing incorporation of the environmental, social and governance factors is part of your research process, ensures that you keep ahead of what the new controversies might be. So for example, fossil fuels were relatively acceptable 10 years ago. What might be coming around the corner, you can keep ahead of that as those risks emerge.
Max Cappetta: Absolutely right, Ross. I think a great example potentially is a company such as AGL. If you look on their website, they're very open about the fact that they are Australia's largest greenhouse gas emitting business. Now, we know for a fact that they have actually moved out of coal steam gas extraction a couple of years ago, and they make a large investment into building their renewable energy sources. Now, the interesting thing may be that they may become the poster child for a company that is transitioning to a low carbon world. Having an insight into the way that they are managing those environmental risks can potential give investors an insight about when might be the best time to embrace some of these companies and actually be part of the way that they can transition to avoid the downsides of climate risk that may come through in the future.
Ross Kent: Max, thank you very much. Some really important takeaways there for me at least. I think the simple re-balancing of the capital you freed up, avoiding the sin stocks, as you put it, isn't so simple when you have to take into account the need to remain diversified and exposed to the companies that your judgment is going to have yielding the better returns over time. Thank you.
Max Cappetta: Thanks, Ross.