Romil Patel looks at modern sustainable investing and how it is attempting to reach a level of coverage beyond Europe.
“If one looks at the amount of column inches, conferences and videos on ESG, you’d think it was a recent phenomenon, but ESG investing has been around for decades,” says Andrew Parry, head of sustainable investing at Hermes Investment Management.
ESG – or environmental, social and governance investing – is the modern face of responsible investment, a concept that dates back to the Quakers. Indeed, the drive to incorporate ESG factors into investment practices has been boosted in recent years by the United Nations’ six Principles for Responsible Investment (PRI): the number of signatories has swelled from 63 in April 2006 to 1,961 in April 2018.
Over the same period, assets under management (AuM) have rocketed from $6.5 trillion to $81.7 trillion (€70.5 trillion).
ESG evolved as people increasingly recognised the importance of creating a more sustainable, resilient and equitable ecosystem. Whether it’s the rise of populism or an increase in the awareness of climate change and its impact on day-to-day lives, we have hit an inflection point in our understanding of it.
And in a world of megatrends comprising climate change, resource scarcity, demographic and social change and technological breakthroughs, to name a few, investment managers shoulder a vital responsibility to the broad community and the environment.
Part of that is having a long-term approach to investing and taking on responsibilities by engaging with companies to try, where necessary, to encourage improvements in outcomes. Aligning investments to the UN Sustainable Development Goals (SDGs) is becoming a central theme.
In 2016, $22.89 trillion of assets were being managed under responsible investment strategies globally – a 25% jump since 2014, according to a Global Sustainable Investment Alliance report.
European assets made up $12.04 trillion of this. “Clearly, sustainable investing constitutes a major force across global financial markets,” the report stated.
As regulators push fund managers to think more long-term, there is little doubt that ESG integration into the investment process is increasingly being viewed as a genuine form of risk management as opposed to philanthropic investing. It is about looking deeply into each ESG issue that could have financial implications on businesses and people, and managing them appropriately.
Beyond data, managers face a wide range of challenges when integrating ESG strategies into their portfolio, says Masja Zandbergen, head of ESG integration at Robeco.
These include determining how value is created in an industry, what kind of ESG trends are affecting both the industry and the value creation, asking companies the right questions to assess whether they are really fit for the future and what kind of key performance indicators (KPIs) they should be looking at to see if companies are prepared and if they are making progress. Having the right research that looks at what is financially material is vital for implementation.
We are in the midst of an interesting crossover period from old ways of thinking about responsible investment to new ways of doing it. While we are not in the eye of the storm yet, we are certainly in transit. But with no one-size-fits-all approach, how can managers overcome key obstacles to successfully achieve a wide level of ESG coverage?
The global picture
Having once been a peripheral, box-ticking, compliance-driven exercise, ESG is forming a critical part of the investment process, driven by detailed scrutiny and client demand. In Europe, 40.3% of pension fund investors’ portfolios factor in ESG principles, a figure that rises to 43.3% in Canada, according to the 2016 ‘Schroders Global Investor Study’.
“You’re now seeing a new generation of investment analysts who are actually saying these are not extra financial factors, they are factors which do drive financial issues, but you might not see them in the immediate next two quarters,” says Sarah Wilson, chief executive of voting services group Minerva Analytics.
In the global context, implementing ESG integration has been far from homogeneous. Whereas ESG investing has taken a foothold in Europe, it is still in its infancy in the US. “There’s been a ton of conversation around ESG investing, but it hasn’t actually translated into actual investment,” says Brendan Powers, senior analyst at Cerulli Associates.
In the US, just 20.1% of the portfolio of pension fund investors is allocated according to ESG principles, compared to 21.4% in the Asia-Pacific region.
“The most common obstacle for financial adviser adoption of ESG strategies in the US is that they still perceive that there won’t be market return. There’s some education to be done,” says Powers. “One of the big issues there is they still perceive investment products incorporating ESG factors don’t have the same performance as the funds they’ve been using forever.”
From a US perspective, he adds, asset managers consider the top five issues for incorporating ESG factors into investment processes to be:
• Board issues and composition (97%);
• Climate change and carbon (89%);
• Bribery and corruption (89%);
• Labour standards (88%); and
• Executive compensation (86%).
Despite the apparent gulf in ESG integration between Europe and the US, it is important to note that issues overlap across geographical boundaries and attitudes are rapidly changing on the other side of the Atlantic.
“With ExxonMobil in 2017, Ceres data shows shareholders voted 62% in favour of resolutions that called for the company to assess and disclose how it’s preparing its business for the transition to a low-carbon future,” says Petra Pflaum, chief investment officer for responsible investments at DWS.
“Two years previously, similar resolutions at other companies only averaged 23% support. So you really see a mind shift that there’s more engagement, more proxy voting supporting those initiatives than in the past years. There’s a huge change in comparison to the last ten or 15 years.”
Amid the waves of change comes opportunity. While European companies tend to face higher pressure in terms of how climate change is affecting their business compared to their US counterparts, investors can pull various levers to accelerate global progress.
“We’re able to use our voice, our vote and the fact that we are a global investor to put pressure on US companies through engagement, or to enter into dialogue with them to say, ‘Just because you’re not facing the same regulatory pressure or investor pressure to disclose how climate change is impacting your business, it doesn’t mean that the regulatory and the transitional and physical challenges of climate change are not relevant to you,’” says Rob Walker, managing director and a regional head of the asset stewardship team of State Street Global Advisors.
“So you should be talking about this, because it will have an impact on your business and is something that investors want to hear about – and the more you talk about this and disclose, the easier it is for investors to understand the potential risk and opportunities that might be facing your business.”
In other regions, the ESG landscape is also taking shape. Having been relatively quiet on ESG, Asia is driving through stewardship codes (in Japan, Hong Kong, Taiwan and elsewhere) and talking about SDGs and sustainability issues. Not being tied to US or European conventions, these areas are starting to find their own identity. “That’s probably healthy,” says Wilson. “It creates diversity because we don’t want an ecosystem which is just based on things like 12 criteria that’s been designed by an index house.”
Designed for governments rather than as an investment tool, the SDGs are a set of 17 global goals, targets and indicators that focus on development in key areas. Targets range from the eradication of poverty to clean energy and the maintenance of peace, justice and strong institutions.
Companies provide a great mechanism for delivering many benefits, but not exclusively. Achieving the SDGs by 2030 demands a truly collaborative approach that involves governments, NGOs, companies and individuals: all of us have a responsibility to reduce waste, for example.
Looking for opportunity is in the DNA of global asset managers and they are now thinking about how they align investments with the SDGs. But with such a broad set of goals that aren’t exclusive to the investment industry, is the scope of their impact limited?
“When you look at peace and justice, companies do have a role,” says Hermes’ Parry. “They have to act responsibly in nations like the Democratic Republic of Congo.” The DRC has an estimated $24 trillion in mineral reserves and supplies some two-thirds of the world’s cobalt, according to reports. The mineral is vital to rechargeable batteries, but its extraction has also been linked to grave human rights abuses.
“If companies’ activities support despotic regimes, then they’re not in a position to be supporting the underlying objectives of SDG 16 [peace, justice and strong institutions] and in the long run, operating a business in a dictatorship and a despotic regime probably is not good for your long-term value creation because one day I can probably almost assure you, they will take away your assets,” says Parry.
Investment managers must think holistically about the broader impact. While acting as stewards, they also have to act collaboratively and engage with companies and other shareholders to try and encourage the best outcomes through better behaviours.
The maximisation of short-term financial returns in the finance sector in 2008 proved to be disastrous because it hit systemic risks that were building up.
The direction of travel with ESG is promising, since it creates a new environment in which capitalism is responsible for a sustainable set of outcomes and is not just about maximising short-term wealth.
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