Melior founders talk sustainable investing

Climate risks are broadly acknowledged, but there is less understanding of how the degradation of nature can damage company earnings. Nature risk needs to become a more immediate and inter-related consideration for boards, not an afterthought. 

Sydney-based Melior Investment Management says it puts ESG at the centre of everything it does and wants companies and directors to start considering and reporting on nature risk. It seeks to create positive impact through the 17 United Nations’ Sustainable Development Goals (SDG) at the same time as it produces competitive returns. Its backers include Mike Cannon-Brookes’ private investment vehicle Grok Ventures and private equity investor Adamantem Capital.

The fund’s co-founders, CEO Lucy Steed and CIO Tim King, are also pushing for a shake-up of board elections and for more board diversity.

“What's different about Melior is that we don't have an ESG specialist who sits on the side and a fundamental investment team sitting in the other part of the business,” says Steed. “The investment person has assessed the company's impact in terms of its core good and service, how it operates across those 105 [ESG] factors. Then they run through their financial assessment and they integrate all those things in the way they think about the company.”

The fund is particularly focused on nature risk, notes King. Although it’s not on the radar of many executives and directors, most companies rely to some extent on nature, which includes biodiversity, soil and water. He expects nature risk will quickly start to attract a lot more focus from companies and investors in the same way that climate risk does now. “We face a climate crisis, as people call it, and we certainly face a nature crisis,” he says.

While climate risks are broadly acknowledged, there is less understanding of how the degradation of nature can damage company earnings. King offers three examples. Potential varroa mite infestation in Australia poses a risk to both honey bees and agricultural companies that rely on those bees to pollinate crops. A drought in Taiwan in 2021 led to the government cutting water allocations to chip makers, disrupting manufacturing in the industry; and in Germany this year, environmental groups called for a consumer boycott of “drought berries” grown in Spain after Iberian strawberry growers used water from ecologically fragile wetlands during a prolonged drought.

King says directors mostly recognise that an “ESG mishandle” can present real risks to the business, and he gets a good hearing when he engages with directors on nature risk. However, he adds they are concerned with how complex gathering and reporting on nature data will be, even compared with carbon reporting, which measures only the single variable of carbon emissions.

“This isn't a thing that companies have had to do before and it's complicated,” he says. “It involves lots of science, whether it's botany, geology or hydrology. That's expensive — and there's a shortage of talent.”

But he also notes that if the government mandates a new suite of ESG factors in addition to the looming introduction of climate risk reporting, these will have to be audited and directors will sign off on them, just as they would with the financial statements. Directors will need to have the skills to assess whether there has been a reasonable attempt to report the information accurately.

Managing the nature risk

In its consultation on the introduction of climate- related disclosure based on the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, Treasury also queried adding nature-based reporting. The Taskforce on Nature- related Financial Disclosures (TNFD) is running a pilot program of its latest version of the disclosure standards and Melior has been encouraging companies to take up the trial standards to familiarise themselves and provide feedback.

The starting point for directors is education, says King. They can look at what the International Sustainability Standards Board (ISSB) is proposing and what the Australian Accounting Standards Board (AASB) is saying. Europe is ahead of Australia on sustainability reporting and can provide a useful pointer to where Australia might go on nature risk. Directors should also start preparing their organisation for the fundamental change in accounting that is coming down the line.

Nature risk forms a “key part” of Melior’s ESG risk assessment when it considers investing in companies. King expects that just as providers of capital are avoiding investing in and lending to carbon intensive companies, they will also start avoiding those companies that harm nature. “The providers of capital are worried about things I'm worried about because they don't want to be lending to a company that's about to be sued or about to be caught up with some media campaign,” he says.

With meteorologists warning of a potential return of an El Niño weather event in 2023, Australia is possibly heading into a prolonged drought. Melior will want to know how that drought could affect water-dependent companies and their earnings or reputations — and how companies will manage that risk. But without the introduction of TNFD standards, there’s currently no standardised information and Melior must do its own research with limited information.

The introduction of nature reporting might lead to companies setting targets for becoming “nature positive” — doing more good for nature than harm — in the same way that looming emissions reporting has prompted many companies to set 2030 emissions reduction targets. All of this fits into Melior’s broader view that ESG represents a material risk for companies, be it their ability to attract capital, the cost of capital, reputational risk, litigation risk, regulatory risk or policy risk. A recent IBM Institute for Business Value study showed companies seen as ESG leaders are 43 per cent more likely to outperform their peers on profitability, which King says directly accounts for Melior’s top- quartile investor returns over the past four years.

Melior seeks to invest in companies that produce products and services that align with SDG because such companies have a structural tailwind behind them. “They're going to have less reputational and litigation risk, a lower cost of capital,” says King. “That translates into the financials. It's actually value creation from those sorts of companies.”

The fund engages with the CEOs and CFOs of its portfolio companies as it conducts investment due diligence and this can often lead to a board presentation where it educates directors and connects them with people who can help with ESG.

Investing with a conscience

Melior was founded five years ago by Steed and King with backing from investment manager Adamantem Capital. King and Steed both have extensive experience in financial services, Steed at BT Financial Group and AMP Capital, and King at Colonial First State, Citigroup and Deutsche Bank.

Adamantem was already applying a social/ environmental lens to its private equity investments and wanted to start an equity investment arm to do the same.

“Our underlying idea was that you can make better returns as an investor if you're proactively managing the sort of environmental and social risks that are coming on to company balance sheets,” says MD Rob Koczkar. “Lucy and Tim wanted to pursue that in a public market setting, which was consistent with our overall philosophy.”

Melior uses three “impact levers” to drive change. The first is by allocating capital to companies it considers will have a positive impact. Second is public advocacy — making public submissions and speaking to the media and at universities. Finally, there is active corporate stewardship — engaging with companies to improve their positive social and environmental impact. It sees a huge opportunity to create change through the ASX 300 companies that collectively employ about two million workers and account for about a third of Australia’s scope 1 carbon emissions.

King notes Melior gains good access to company executives and boards, despite its relatively modest size when compared to some of the giant superannuation funds, because it does its own research and companies want to know where they stand on Melior’s investment list of 105 ESG factors.

Backing diversity

Steed highlights UN SDG 5.5 on improving the participation of women in the workforce and their representation in leadership positions. Melior also supports superfund HESTA’s 40:40 Vision for ASX 300 companies.

Melior is seeking to invest in companies with more than 10,000 employees that show gender leadership, in chair positions, board seats and CEO appointments. “We will look at allocating capital to those companies, not just because we think that creates positive social impact, but also because the empirical and academic evidence shows it actually leads to better returns,” says Steed.

Australia is ranked equal first globally for women graduating from university, yet only six per cent of the CEOs of ASX 300 companies are women. This can lead to fewer women taking chair roles, because they are often filled from the ranks of former CEOs. Steed says while the 30% Club is making progress, only 11 per cent of ASX 300 chairs are female.

Steed and King are strongly focused on optimal board composition, particularly gender and age. Steed points out the median age of Australians is 38, but the average director age is 61. “You may be missing out on different perspectives that don't come naturally to that age cohort,” she says, adding that perspectives on sustainability from the younger generation, willing to pay a premium for sustainable companies and products, could be valuable.

Ethnicity is another factor in board diversity and Melior would like at least one member of every board to come from a minority, but has found it hard to gather useful data on this.

The fund would also like more information about directors nominated to the boards of companies they invest in. “We as investors should have the opportunity to hear from the candidates as to why they should be elected to the board and have the opportunity to ask them questions before the AGM,” says King. “Because once it’s got to the AGM, it's too late, we’ve all voted.”

“How can we make this more like an election?” asks Steed. “It's not something that a lot of fund managers focus on — and we focus on it a lot.”

King rates director skills matrices as “completely inadequate”, noting that most don’t even put director names beside the individual skills, forcing Melior to contact the companies to discover which directors have which skills. He adds that there is inadequate linkage of ESG metrics to executive remuneration, even in those companies that say it’s a core part of the business — and of risk mitigation and value creation. King says Melior usually votes its proxies against remuneration reports that don’t do this, but always gets the company’s perspective and warns companies ahead of a “no” vote.

AICD CGI resource

As part of the Climate Governance Initiative (CGI) Australia, the AICD and MinterEllison recently adapted a briefing, the Commonwealth Climate and Law Initiative (CCLI) report, Biodiversity Risk: Legal Implications for Companies and their Directors, for an Australian audience. It covers:

• Companies’ dependencies and impact on biodiversity
• Assessment and disclosure of biodiversity risks and opportunities
• Market, social, regulatory and legal contexts
• Questions directors should be asking to assist their oversight of biodiversity risk.

This article first appeared under the headline 'Point of Impact’ in the September 2023 issue of Company Director magazine.