Environmental, social, and governance factors are rapidly gaining investor favour worldwide. As more myths around sustainable investing get busted, savvy investors are starting to look for businesses that embrace sustainability as part of their corporate strategy.

The ongoing boom in sustainable investing is proof that ESG issues are now key economic determinants with significant bearing on businesses and investors.

“One need look no further than the nearly fourfold increase in assets that flowed into sustainable funds in the United States last year,” says Jon Hale, Morningstar’s global head of sustainability research, adding that sustainable funds “attracted more assets in just the fourth quarter of 2019 than in all of 2018.”

To find Australian companies that score highly on ESG, we’re turning to the Morningstar Australia Sustainability GR AUD Index. The index represents a list of equities that score highly across environmental, social, and governance considerations in distinct economic areas.

MORE ON THIS TOPIC: ESG and sustainable investing: a guide

The index holds large and mid-cap stocks within the Morningstar Australia Index that have low ESG risk ratings and a high Morningstar Sustainability Rating. To assess company risk, Morningstar uses the company level ESG Risk Rating from Sustainalytics.

To be eligible for the index, securities must:

  • Have a controversy score of 3 (out of 5) or lower.
  • Not belong to the ‘Severe’ ESG Risk Rating Category.
  • Not have:
    • More than 50 per cent tobacco products involvement by revenue
    • Any involvement in production of controversial weapons
    • Any involvement in the manufacturing and sale of firearms to civilian customers
    • Any involvement in the manufacturing and sale of key components of small arm

Morningstar Premium subscribers can view the index’s 63 holdings here. From this list, we've pulled out the stocks with the lowest Sustainalytics ESG Risk Score. Sustainalytics is the leading independent global provider of ESG and corporate governance research and ratings.

Unsurprisingly, the list is dominated by companies from sectors that generally have minimal ESG risk, such as real estate—not the higher-carbon-risk sectors like energy, utilities, and basic materials.

These names aren’t all trading in buying range today according to our metrics, but they’re all choices for an ESG stock watchlist.

Top 10 lowest ESG risk scoring companies in the Morningstar Australia Sustainability GR AUD index

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Source: Morningstar Direct

Here's a closer look at three stocks on the list:

Vicinity Centres VCX

Vicinity is Australia's second-largest retail REIT, with a book value of more than $15 billion. Assets are skewed to larger shopping centres, with a weighting of 67 per cent to major regional malls, 19 per cent to subregional malls, 1 per cent to neighbourhood malls, and 12 per cent to outlet centres.

Sustainalytics has given the REIT a very low ESG risk score, saying it is at negligible risk of experiencing material financial impacts from ESG factors, due to its low exposure and strong management of material ESG issues.

"Vicinity Centres’ performance and ongoing success depends on that of its customers," Sustainalytics says.

"Providing high quality buildings and delivering positive experiences are crucial for the company to maintain a strong and mutually beneficial relationship with customers.

"Additionally, the company’s large property portfolio has a wide environmental footprint, and tenants in the company’s markets increasingly prefer green buildings.

From a valuation perspective, Morningstar equity analyst Johannes Faul has a 4-star rating on the stock, but says the risks are high.

"A risk is that some sub-segments that may be hit harder and longer, notably tourism and luxury," he says. "Vicinity’s locations are more exposed via CBD sites like Sydney’s QVB, and Melbourne Central, and a hotel at Chadstone. These risks factor into our bear-scenario, should the economic disruption linger, and our bear case also assumes a dilutive rights issue."

However, Faul believes the downside is largely priced in, and there is likely upside in Vicinity securities.

Transurban Group TCL

Transurban Group is a major toll road investor with concessions to operate 14 Australian and three North American motorways. Sustainalytics says the company is at low risk of experiencing material financial impacts from ESG factors, due to its low exposure and strong management of material ESG issues.

"As a long-term custodian of roads, Transurban is responsible for ensuring and improving road safety," Sustainalytics says.

"The company also needs to ensure that it maintains strong relations with neighbouring communities in order to avoid disruptions and costly project delays that can occur due to community protests for projects under development.

"Furthermore, Transurban has close and frequent interactions with governments and regulators, which requires strong management of corruption risks."

However, Transurban has a moderate level of controversies, stemming from quality and safety issues, and anti-competitive practices in connection with its bid for a majority stake in the WestConnex road project in Sydney.

Morningstar equity analyst Adrian Atkins says coronavirus has hit Transurban's traffic hard. Traffic volumes on Transurban's Australian roads have fallen close to 40 per cent in recent days since lockdown laws were enacted, compared with the same time last year. But longer term forecasts as well as Transurban's wide moat and medium uncertainty ratings are intact. 

"The firm will be hard-hit by strict lockdowns, but these should only last a few months and we think it has the financial strength to ride through this difficult period," Atkins says.

JB Hi-Fi Ltd JBH

JB Hi-Fi is a specialty discount retailer of branded home entertainment products. The group's products particularly focus on consumer electronics, electrical goods, and white goods through its JB Hi-Fi, JB Hi-Fi Home, and The Good Guys stores. The company primarily operates from stand-alone destination sites and shopping centre locations in Australia and New Zealand.

Sustainalytics says the company is at a low risk of experiencing material financial impacts from ESG factors, due to its low exposure and average management of material ESG issues. However, analysts say it is exposed to labour relations issues and skill deficit due to its employee base and qualification needs. They also make note of JB Hi-Fi's carbon footprint, affected by the nature of its operations and the source of energy used to power these operations.

"Increasingly stringent carbon and energy regulations could lead to higher energy prices and larger associated costs for the company, as well as compliance issues," analysts say.

JB Hi-Fi was undervalued as the stock market fell in March, but has since rebounded, and is now at a 23 per cent premium to fair value. Faul anticipates that JB Hi-Fi could emerge in a strengthened position when the cycle turns.