Over the last ten years, ESG criteria have increasingly become part of the mainstream for many pension funds and asset managers. But Mirabaud Asset Management believes this is just the start of a longer journey.
Back in the 1990s, institutional investors were most interested, if they were interested at all, in the G (or governance) part of the ESG equation. High-profile industry figures campaigned successfully against rolling three-year contracts, which they viewed as grossly unfair because directors were financially rewarded – whether they succeeded or not. Their actions led to the creation of the UK Corporate Governance Code. But ESG has moved on a long way since then.
Today, the E and the S part of the equation are equally, if not more, important. In particular, the Paris Accord in 2015 on greenhouse gases has done much to highlight the Environmental aspect. And subsequent initiatives from numerous countries, including France, the Netherlands and others have highlighted ESG in the minds of the general public. Indeed, Moody’s recently published a timely report on the potentially devastating impact of climate change in Europe.
But it’s often in emerging markets that the need for more ESG is most pressing.
Mirabaud’s fund managers regularly visit China, flying there at least once a year. As they begin their descent into Beijing airport, they often pass through a thick cloud of smog just before they land. And when they disembark, they’ve often struck by the number of people wearing face masks in the streets.
Pollution is a huge problem in the developing world generally, not just in China. It affects everyone, but in particular it has a disproportionately negative impact on children and old people, who are regularly warned not to stay outside for too long for health reasons. True, the Chinese government is making concerted efforts to reduce pollution levels, but throughout Asia and other parts of the developing world such as Latin America, it remains a major issue.
Putting ESG to work
The principal reason why companies embark on a sustainable strategy, however, is to reduce risk. Companies that employ good governance are sensitive to the environment, have strong social programmes in place and take a long-term view. In combination, all these factors can help to minimise risk.
So what tools does an asset manager or pension fund need to implement a comprehensive ESG strategy? The three principal approaches are Exclusion, sometimes known as negative screening; Positive selection, which seeks to integrate ESG; and Impact investing, which invests in companies that pursue a positive social or environmental impact.
At Mirabaud, we principally focus on Positive selection for those strategies that integrate ESG considerations into their approach. We take ESG factors into account when evaluating and choosing investments because we believe they have a sustainable and positive impact on financial performance. As active, engaged managers, we also believe that there’s no substitute for in-depth, bottom-up company research and ongoing active engagement with companies. This deep due diligence, which we’ve been practising for many years, is essential to gaining insights into a company’s management quality, business strategy and potential risk exposure. This research is combined with analysis from ESG data providers, such as Sustainalytics.
To further strengthen our approach, we have a dedicated ESG team that sits independently from the portfolio managers. Our approach to ESG integration is continuing to evolve and our next area of focus is to develop a process around engagement over and above what we currently do on the research side.
Many firms say they adopt ESG frameworks, but in reality, few do it fully. Most do so by utilising an Exclusion-based approach, where they exclude certain stocks or sectors such as tobacco or armaments. This is often because it’s the easiest framework to operate – it’s a valid method but does not go far enough. Creating an integrated approach is more challenging because it involves combining ESG research from third parties with traditional in-house research and engagement. According to Eurosif, the pan-European SRI organisation that promotes sustainable investing, Exclusion is the most popular approach.
Historically, the principal developments within ESG have occurred in equities. However, more recently, fixed income managers have started to take an interest in ESG, both from a credit standpoint and a government standpoint. For example, they might look at a country from a macroeconomic level and its willingness to pay its debt - a measure of sustainability. Or they may use ESG analysis to look at credits just as equity managers do with companies.
ESG is growing
According to a recent report by Create Research, 36% of pension assets are currently invested in ESG strategies and 61% expect this to rise over the next three years1. But in terms of implementing ESG strategies, as we’ve already seen, there’s clearly no one-size-fits-all approach. However, this is understandable given that asset managers and pension plans are often at different evolutionary stages when it comes to implementation.
The barriers to integrating ESG most often cited include the time it takes to integrate analysis into a portfolio, the cultural change that needs to occur within a company, and the fear that ESG investing might hamper returns.
On the last point, there have been a number of studies over the last few years that suggest ESG investing does indeed add value. In 2017, for example, Boston Consulting Group suggested companies using an ethical approach were more profitable and highly valued2. And Morgan Stanley reached a similar conclusion when, having examined 10,000 mutual funds over seven years, they concluded that sustainable funds exhibited slightly higher returns and lower volatility than traditional counterparts3.
At Mirabaud, there’s no doubt in our minds that ESG will continue to grow in popularity. Given the weight of client demand, alongside other influences, such as governments and regulators focusing on areas such as sustainability and governance, ESG will continue to expand. We also believe that we’ll see a closing in the gap between Europe, the US and Asia in terms of client experience. Indeed, ESG integration in Asia has the potential to accelerate quickly.
There’s a sea change happening in Asia, driven in part by government policy, which will further shift investor attitudes in favour of ESG. To return to our account of the smog at Beijing airport, as part of its Action Plan for Winning the Blue Sky War, the Chinese government recently passed regulations to reduce the use of coal for domestic consumption, insisting that households find alternative, cleaner sources. More generally, while Emerging Market economies currently lag behind Europe and the US in terms of ESG, they have the capability to enact environmental legislation far more quickly than the West.
Arguably one of the biggest drivers behind greater adoption of ESG strategies is demographics. As the Baby Boomer generation begins to peak, the Millennial generation has assumed ever greater significance. According to Create Research, 85% of Millennials are reportedly interested in or actively engaged in ESG investing4. And over the next ten years they will become the largest employee group. Whichever way you look at it, the trend towards greater ESG engagement will continue to grow and grow.
1 – Create Research, Back to Long-Term Investing in the Age of Geopolitical Risk. 2017
2 – Total Societal Impact: A New Lens for Strategy. Boston Consulting Groupd. 2017
3 – Sustainable Investing Myth Busters. Morgan Stanley. 2017
4 – Amundi-CREATE 2017 Pension Survey Report
Disclaimer: The contents of this document are illustrative only and shall not be construed as an offer or a recommendation to subscribe for, retain, pursue or dispose of fund units, shares, investment strategies or courses of dealing. The sources of the information contained in this document are deemed reliable by the issuer. However, the accuracy or completeness of the information contained in this document cannot be guaranteed, and some figures (if quoted) are only estimates. Past performance is not indicative or a guarantee of future returns. Fund values can fall as well as rise, and investors may lose the amount of their original investment. Performance figures if quoted do not take into account subscription and redemption fees and costs. Any values or holdings quoted are relevant only on the day they are issued and investment values convictions and strategies may be revised without notice. This communication may only be circulated to Eligible Counterparties and Professional Investors and should not be circulated to Retail Investors for whom it is not suitable.
Issued by Mirabaud Asset Management Limited which is authorised and regulated by the Financial Conduct Authority for the conduct of investment business in the United Kingdom under firm reference number 122140.
“Mirabaud” “MAM” and “Mirabaud Asset Management” © are trading styles of Mirabaud Asset Management Limited and associated Mirabaud Group companies.
©2018 funds europe