Embracing complexity for sustainable returns

Ausbil says investors who embrace the complexity of dynamic company ESG, and sustainability profiles may be better placed to assess long-term risks and opportunities.

Because all companies touch on multiple ESG domains, and there is usually never a simple view that captures everything that matters, Ausbil believes that it is important to embrace complexity and assess companies holistically on their ESG and sustainability credentials, whether they are improving, how they compare to others, and how they compare to global best practice.

It is important to understand that almost every company will show up exceptions or weaknesses, but for Ausbil, this is where the real action occurs, where active engagement can make a difference.

It is active engagement that holds it all together, in the actioning of the empirical analysis underpinning Aubsil's view on any company, especially the exceptions.

How to make sense of the complexity in assessment

There are many companies that are leaders in sustainable practices, yet they can go unnoticed because their achievements do not make for simplistic categorisation.

Decades of work in ESG and sustainability has shown that every company's sustainability credentials, record and outlook is a complicated and changing thing.

Rather than ignore this, Ausbil believes a philosophical and procedural approach to sustainability should embrace complexity, and that it should support active sustainable investment decisions.

What a sustainable company looks like

A high-scoring sustainable company is one where the owners and management have established a business model that goes beyond simply becoming a market leader in its segment but incorporates sustainability considerations in its design and execution.

These are companies that 'pay it forward' for future generations, for their workforce, for society, for the environment, and for the future sustainability of the economy. These types of companies find a nexus between being profitable and successful and leaving a legacy that is beneficial for society. There is no one industry, but rather many places where these companies are found.

From an ESG perspective, higher-scoring sustainable companies demonstrate leadership in areas such as governance and board independence, sustainability practices and transparency, diversity and workplace flexibility. Higher-scoring sustainable companies also demonstrate a clear awareness and ownership of the social purpose and responsibility in their business, an area of growing importance. Finally, such companies are connected with, and tuned into, the environment in which they exist, the health and wellbeing of the global communities in which they operate, their impact on the environment now, and into the future.

To help visualise company sustainability, Ausbil developed an ESG Scoring Spectrum which helps engage actively on how both companies can improve on sustainability measures, and where they need to work to maintain forward momentum for improvement. The figure uses Australia's big four banks as an example.

Figure 1: Ausbil's ESG Scoring Spectrum: Leader and laggard of Australia's four largest banks

Areas of focus on Ausbil's sustainability radar

Modern slavery and human rights in supply chains remains a key ESG engagement issue as it impacts a significant proportion of Australian listed companies. Modern slavery is a complex and multifaceted issue for investors. It is both a human rights concern and a source of financial and systemic risk that investors cannot fully diversify away. However, as global regulatory expectations rise and societal tolerance for exploitation declines, modern slavery may present material implications for earnings sustainability, reputational standing, and long-term investment performance.

Because of the prevalence of modern slavery globally, as a fund manager it would be an impossible task to construct a portfolio that is considered entirely free from the probability of modern slavery risk. Modern slavery is a systemic risk, particularly deep down in company supply chains. As a result, Ausbil believes investors can play a role through engagement with individual companies, policy advocacy efforts and collaboration with other institutional investors. For example, Ausbil Head of ESG, Mans Carlsson has undertaken numerous field trips covering supply chains.

In engagements with companies on modern slavery, Ausbil are looking for best practice approaches, and are asking companies to look through their entire supply chains, and the supply chains to their supply chains.

Modern slavery is a key risk for companies with a significant numbers of products sourced globally, like Woolworths and Wesfarmers, the owner of Bunnings. One of the strengths seen in Woolworths' approach has been to address the root causes of human rights issues in global supply chains, rather than implement 'band aid' solutions. Because Woolworths is such a large company, their improvements on responsible sourcing has also had a ripple effect in the wider economy, which means it has been particularly worthwhile to engage on this issue.

Figure 2: ESG Scoring Spectrum: Woolworths and Wesfarmers

Climate risk is perhaps the peak issue of our time. Yet understanding climate risk, its mitigation and decarbonisation from an investor's perspective is complex. The science is very clear. The world needs to decarbonise to avoid a potential ecological disaster. The longer we wait, the costlier it will be for the economy, the environment and humankind.

From an investor's perspective, rather than simply assessing carbon emissions intensity, which is backwards looking and ignores issues like physical climate change risk, revenue op­portunities from decarbonisation and has other potential flaws, Ausbil believes that the best way is to assess climate risks through a 'scenario analysis' approach.

This approach is forward look­ing and can evolve as assumptions change. Ausbil performs this analysis annually through Net Climate Change Risk (NCCR), a proprietary research tool, effectively a quantitative model to assess, score and rank climate change risks.

This assesses all aspects of climate change to a company's business model, with scoring anchored on International Energy Agency (IEA) scenarios for total energy demand and energy mix. Importantly, Ausbil's NCCR approach assesses the credibility of each company's decarboni­sation targets.

It is currently working with two companies which have shown leadership in this area, Pilbara Minerals (PLS) and Lynas Rare Earths (LYC). PLS used to be somewhat of a laggard on general operational ESG risk management, but it is a company with which Ausbil has engaged and where it has seen significant forward momentum on ESG issues. For instance, the company has established a 5-year sustainability plan and has accelerated its decarbonisation / water risk management in recent years. Like PLS, Lynas Rare Earths is a company that has demonstrated good management of the high operational risks they face in terms of mining rare earths, such as chemicals, runoff, tailings and radioactiv­ity, which reflects well in the overall ESG assessment.

Figure 3: The ESG Scoring Spectrum for Lynas Rare Earths and Pilbara Minerals

Traditional owners were brought into sharp focus for both the community and investors after the Juukan Gorge incident. Rio Tinto was rightly punished for Juukan Gorge, and at the time, Ausbil was strident in its engagement with the company. However, since Juukan, the positive impact has been a significant improvement across the industry in their relationships with traditional owners. From an ESG perspective, Ausbil have been encouraged by Rio Tinto's (ASX: RIO) improved ESG risk management in many areas.

Figure 4: The ESG scoring Spectrum for Rio Tinto

How Ausbil is able to influence change

Ausbil's proprietary ESG research recognises that ESG factors are complex, company specific and constantly evolving, and assesses underlying ESG areas on which it might, where appropriate, engage on. The complexity of this intelligence moves well beyond classic fundamental analysis. The detailed empirical data Ausbil captures from its ongoing engagement, and qualitative analysis of the companies it covers provides a benchmark for future company engagement, for relative comparison to peers and best practice, and in assessing momentum on ESG over time.

In terms of knowledge, skills and expertise required to support engagement with companies, Ausbil's belief is that effective engagement depends on close collaboration between the ESG team, stock analysts and portfolio managers and communicating with companies in a practical and commercially informed way.

The ESG team includes a combination of investment experience, expertise in corporate governance and specialists ESG knowledge, with decades of shared experience. For engagement to be effective, it is important to understand the company's operating context and the constraints it faces. The process also involves identifying examples of what is leading practice in the company's respective industry or sector and encourage, in a consultative way, companies to consider those practices. Where appropriate, Ausbil may also use its voting rights as part of the broader stewardship approach.

Does sustainable investing make money?

In Ausbil's experience, integrating ESG research has not required a sacrifice of returns.

Relatively passive approaches to sustainability based only on exclusions do not make the most of the available alpha tools, as can an active investment approach that takes full advantage of the ESG intelligence that comes from dynamic active engagement with companies.

It can be seen in the total return performance that the actively managed Ausbil Active Sustainable Equity strategy steadily advances over time against both the index, and a simple exclusion policy which hugs close to the index on compound excess returns.

ESG helps perfect a long-term investment approach as it helps make invest­ment decisions that look at a kaleidoscope of depleting and terminal risks to a business model that both traditional analysis and simplistic exclusion strategies usually miss.

Genuine active engagement means maintaining an ongoing conversation with all companies in the potential investment universe, even when they currently have un-investable ESG scores.

Figure 5: Sustainable performance and the impact of exclusions (net of fees)

Sources: Ausbil, FactSet, 30 June 2026. Sustainable Strategy is the performance of the Ausbil Active Sustainable Equity Fund (net of fees) since inception in February 2018. Benchmark is the S&P/ASX 200 Accumulation Index. Benchmark with Exclusions is the S&P/ASX 200 Accumulation Index less excluded companies based on Ausbil's controversial activities exclusion policy.