Australia’s changing narrative: investment risks and opportunities

Investment into Australia is increasing as private capital seeks to balance risks across portfolios and find relative safe havens that can still provide attractive returns.  

Australia’s comparative safety as an investment destination is its main selling point. But there is also considerable risk in several areas: its geopolitical positioning in the US-China rivalry, increasing ESG regulation, unreliability in the renewables sector, and the longer-term impact of an aging population and slowing productivity.  

What are the factors that investors need to consider as they assess opportunities? What can derail investments or undermine returns? 

Geopolitics: an ally and a trading partner

While it is considered a relatively benign political environment domestically, Australia has by no means escaped US-China tensions. It has attempted to balance its role as a key US ally in Asia on the one hand with its role as a strategic trading partner for China on the other. This balance was lost in 2020 when diplomatic tensions led to China imposing a raft of trade restrictions on selected Australian industries, with barley, beef, wine, lobsters and coal most adversely impacted.  

For the most part, Australian exporters were able to find other markets to replace dampened Chinese demand. However, China has more recently sought to renormalise relations, ending its tariffs on Australian wine in March 2024, for example. While a lot of work went into reorienting exports to other markets, the allure of the Chinese market is likely to be strong for many Australian exporters, and the easing of restrictions will be hard to ignore completely. Australian companies may find themselves again heavily exposed to an export market which is uniquely vulnerable to diplomatic interference.  

The reality is that long-term structural barriers remain to smooth trade between the two countries. China de-risking will remain part of the Australian government’s agenda, which has been manifesting in both incentives for investment from other markets, and the implementation of hurdles to slow or halt some Chinese investment.  

One of the Australian government’s approaches to China de-risking is its plan to deepen ties with Southeast Asian markets. The Southeast Asia Economic Strategy to 2040 aims to encourage and facilitate increasing trade from Southeast Asian markets to Australia. Some of the specific initiatives include: 

The Australian government is also implementing initiatives to increase the burden on companies investing in certain sectors where that investment is considered inconsistent with Australia’s national interests. This has sometimes meant blocking investment from companies affiliated with states not geopolitically aligned with Australia. The Australian government announced earlier in 2024 that it would accelerate approval for international investors into Australia but clarified that its support would be for investors with ‘proven records’, specifically citing Canadian pension funds.  

At the same time, the government is implementing additional protections against more sensitive investments, including in Australia’s critical minerals sector, to ensure that foreign-backed projects are in Australia’s national intertest. For example, FIRB blocked a China-linked company from taking over an Australian lithium mine in 2023. Increasingly, investment from geopolitically aligned countries is likely to be ushered along and potentially shielded from competing bids from companies backed or headquartered in countries unaligned with Australia.  

When examining a potential investment in Australia, it is critical to understand which markets a prospective target company is exposed to. Investors should also be aware of which diversification options are realistically available. Investors from Southeast Asian markets in particular should seek to leverage the Southeast Asia Economic Strategy to access opportunity and unlock value in Australia. And investors must also understand that exposure to companies affiliated with states that are geopolitically unaligned with Australia, however tangential, may impact the ability of an investment to receive FIRB approval.

ESG standards: a crucial element of pre-deal due diligence 

Australia has long had a reputation of being less stringent on areas like anti-bribery and corruption or human rights enforcement than the EU or even the US. However, environmental, social and governance (ESG) standards, and how they are represented in corporate governance expectations have been widening in Australia for several years. Companies that fail to meet certain benchmarks are facing adverse action from an expanding group of stakeholders, including regulators, activist shareholders and public interest groups. Not recognising the increasing importance of these matters can have a negative impact on overall value, not just reputation.  

Australian regulators are increasingly flexing their enforcement capabilities, as with the Australian Securities and Investments Commission (ASIC) fining Mercer AUD 11.3m in 2023 in a landmark greenwashing case. The corporate regulator has publicly stated its intention to crackdown on other greenwashing cases in 2024, as well as pursue a riskier litigation strategy and accept more courtroom loses when it comes to protecting investors from poor corporate governance. It is increasingly important to understand the depth and reliability of a target organisation’s governance and sustainability structures.  

Activist shareholders have also shown a willingness to use their vast resources to dictate corporate strategy. Australian billionaire Mike Cannon-Brookes and his stake in Australian energy company AGL is one of the most high-profile examples in Australia. Cannon-Brookes has been particularly public about his disapproval of AGL’s decarbonisation timeline and has used his stake to replace company board members and extract new decarbonisation commitments. Cannon-Brookes also publicly shared that AGL’s poor ESG ranking meant that the company did not have many large, institutional shareholders, making his stake in the company the largest by a factor of up to six, allowing him to wield the influence he has to date. Understanding the disposition of other shareholders in a target investment will help you understand whether there may be long term pressure on company strategy which could adversely impact expected returns.  

Savvy investors will understand that a company’s adherence to ESG standards set today, and those likely to be set or expected in the future, can mean the difference between a successful transaction and one that causes issues and threatens a target company’s valuation. Understanding a company’s track record and internal approach to ESG requirements is now a crucial element of pre-deal due diligence; equally as vital is seeking to understand whether a target company may become the subject of activist shareholders or public interest group action.  

Renewables: do not get lost in the gold rush 

There has been an exponential increase in projects in the renewables space in Australia. The sector has taken off despite the sometimes erratic messaging from various federal government leaders around their commitment to the role of renewables in Australia’s energy transition. 

Regardless of the current rhetoric around nuclear power from the federal opposition, support for renewable energy projects from Australian state and federal governments will likely continue, as investment is incentivised in myriad ways, ranging from the AUD 20 billion “Rewiring the Nation” programme on grid infrastructure to the State of Victoria providing interest free-solar battery loans to households. Indeed, batteries remain a critical area, with Australia seeing a fresh high in investment in large-scale batteries for 2023.  

At Control Risks, we have had numerous clients engage us for pre-deal diligence on partners and co-investors in renewable energy projects. While many, if not most, are run by reputable and reliable parties, the sheer pace and scale of expansion, as well as the incentives available, mean we have identified multiple cases where founders have problematic backgrounds, where management teams are inexperienced, and where ultimate ownership is opaque or even non-disclosed.  

Ensuring you understand the complete background and reputation of other parties involved in an investment is crucial, especially in a sector with high levels of government support and subsidy. Evolving ESG standards are also bound to impact the renewable energy sector with increased reporting requirements, such as modern slavery due diligence, which is likely to hit project operators who will be required to ensure they fully understand their supply chains and comply with reporting standards.  

When reviewing opportunities in the renewables space, be sure to understand the complete background and reputation of the other parties in the investment. Consider which ESG standards, such as modern slavery, may impact your target’s supply chain and fully understand how the company plans to manage those risks. And given the increasingly aggressive approach of FIRB, make sure you prioritise understanding any hidden ownership or offshore linkages.  

Productivity and population: macro threats to long-term policy settings

 The relative stability of Australia underpins much of the sense of safety that attracts capital and investment. However, it is important that any long-term investment strategy considers the potential for a changed Australian operating environment, specifically how an aging population and slowing productivity could undermine the country’s stable platform. 

As we have seen in several G7 nations, productivity in Australia remains a challenge. Australia’s labour productivity levels recently hit a 60-year low. In 2023, the federal treasurer claimed that Australia was heading towards being 40% poorer by 2063 if labour productivity rates remained at current levels. An aging population means reversing this trend will require big, systemic programmes that have meaningful government support or involvement, something that Australia’s 3-year election cycles make challenging.  

It is also noteworthy that the first preference vote share earned by the two major political parties in Australia, the ALP and LNP, has consistently declined at every successive federal election since 2007, when they earned a combined 85.5% of the total vote. In 2022, they recorded their lowest combined first preference vote share since 2007, when they registered a combined 68.3% of the vote. If Australia’s living standards begin to materially falter – something already felt by many people locked out of the country’s housing market – we could see voters continue to move away from the two major parties until minority governments become the norm, and policy certainty from government becomes less likely at each federal election.  

Investors must understand the exposure of any investments to these headwinds and take a realistic look at how dependent returns are on the much-lauded stability of the Australian regulatory and operating environment. By doing this, investors can better contextualise predicted returns and conduct more targeted monitoring.

Familiarity does not mean safety 

Given the uncertain geopolitical and geo-economic context of 2024 and beyond, Australia will remain a choice destination for investors seeking stability and opportunity to find returns across an increasing variety of sectors.  

However, investors should not be lulled by the relative safety and familiarity of the environment. Instead, investors must apply the same rigour to vetting prospective deals as done in more traditionally “risky” markets to ensure a true understanding of the returns on offer. 

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