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ESG: Environmental impact

Wind farmHas the era of austerity harmed socially aware investments, or given it a new lease of life? Fiona Rintoul seeks answers.

Those who advocate adding environmental, social and governance (ESG) criteria into investment decisions have fought to portray these factors as hard financial determiners rather than soft and woolly add-ons. If this is the case – and the evidence, it has to be said, is not overwhelming – then the austerity measures being experienced across most of Europe at the moment may be presumed to promote rather than discourage socially responsible investment (SRI). Is it so?

Certainly, fund managers do not report any let-up in the attention company management is paying to ESG factors. This is partly because ESG is a long game, for companies and investors alike and, once the engines are engaged, it is usually full steam ahead.

“Companies have multi-year programmes, some of which started some time ago,” says Bozena Jankowska, global co-head of ESG at Allianz Global Investors (Allianz GI). “We haven’t seen any evidence of companies scaling back. It’s business as usual.”

But it is not all one-way traffic. Some specifically environmental sectors have fared better than others in the crisis – renewable energy, for example, has underperformed because of regulatory uncertainty and overcapacity, while energy efficiency has outperformed – as have some companies. Even if a company’s bottom line does not affect how much it invests in corporate ESG, it may affect its ability to take on or continue ventures with an environmental or social hue.

“BP, which is under strong financial pressure because of the Gulf of Mexico oil spill, is selling off all its investments in wind farms. Whereas Total, which doesn’t have that problem, has just inaugurated the largest solar production farm in the United Arab Emirates,” says David Diamond, the other global co-head of ESG at Allianz GI.

In some ways, however, the global financial crisis and the austerity measures that ensued have given SRI and ESG a new lease of life.

“Austerity is a consequence of the whole fragility of the financial system, the questioning of light-touch regulation,” says Stuart Kinnersley, chief investment officer at Nikko Asset Management (Nikko AM Europe) and manager of the Nikko AM World Bank Green Bond fund. “Certain things could have been avoided with greater emphasis on ESG type issues.”

Nowhere is this more true than in the fixed income sector.

“The crisis has had a contrasting impact on different sectors,” says Eric Borremans, head of CSR and SRI development at BNP Paribas Investment Partners. “One example is sovereign debt. The bursting of the credit bubble showed that an ESG view adds value from a financial side.”

SRI has, of course, traditionally been less focused on the fixed-income sector than the equity sector. This is largely because “there is little accountability in either government or corporate bonds”, says Kinnersley.

So it is that in France, for example, only 4% of bond fund assets were classified as SRI in a report from Novethic and Groupe Caisse des Dépôts, while 7.7% of equity fund assets were.  

However, as the bond market is a much larger source of capital than the equity market, any real attempt to change corporate behaviour through SRI really must encompass fixed income. In some ways, this is a question of will. ESG analysis of companies can just as easily be taken into account when buying corporate bonds as when buying shares.

In other ways, however, bonds and SRI are tricky bedfellows. Bond holders cannot challenge companies at AGMs or vote down purple pay packages the way shareholders can, so any kind of engagement is much harder to achieve. And, increasingly, fund managers feel they should also assess government debt, where there is little accountability, from a sustainable angle.

“More fixed income managers are doing some basic ESG assessments, and managers among the ESG fraternity are looking at fixed income from a more sustainable angle,” says Kinnersley. “I’m not sure that’s ESG; it’s more common sense.”

The truth is perhaps that it seems like common sense now. However, before it all went horribly wrong in the sovereign debt markets, ESG did not make too much difference.

“We had a situation in 2002 when people suddenly realised that weak governance could be a source of poor performance, but when markets do well again it doesn’t make so much of a difference,” says Borremans. “When the sovereign debt crisis started it became apparent again that issues such as governance can be discriminating factors for corporate and sovereign issuers. The way differences in governance crystallise depends on the market cycle.”

It is a point that institutional investors in bond-oriented France have grasped. Of the €149 billion now invested in SRI assets in France, €107.2 billion is attributable to institutions, according to a second Novethic and Groupe Caisse des Dépôts report. And it is interesting to note that bonds made up 53% of total SRI assets (investment funds and institutional mandates) at the end of 2012 compared with 44% in 2011.

This kind of growth in SRI mandates is partly driven by many institutional investors, such as pension funds having signed up to the United Nations Principles for Responsible Investment.

“Clients no longer ask if they should have an SRI mandate among other mandates, but what strategy they can use to drive ESG across the whole pension fund,” says Diamond.

At the same time, there are changes to ways we invest that complicate SRI. One is increased investment in developing markets. This raises the problem of whether it is possible to apply the same criteria across all markets, particularly when it comes to issues such as corruption.

F&C Investments tries to solve this by having a global set of principles and local guidelines, says George Dallas, the company’s director of corporate governance. As he wrote in a recent paper on business ethics in emerging markets, “This [taking a stand against corruption in emerging markets] requires a strong and consistent message by investors that high business ethics standards should consistently apply to emerging markets as much as they do in the more developed markets — as well as a pragmatic understanding of the challenges faced and the strategies that may have the greatest impact.”

The range of issues being tackled has also widened. One issue that has received a lot of attention recently is tax avoidance by companies. It can be difficult to target individual companies on this issue because company accounts do not always make it clear where profits are made. Some investors, however, are not taking no for an answer on tax avoidance.

“We have examples of investors – maybe pioneers – who are asking for accounts from financial institutions not to be voted if there is no transparency on tax on a country by country basis,” says Diamond. “Some clients are also asking us to look at the dividend policy on a long-term basis. If a company is laying people off but increasing the dividend, they might not vote that through.”

In any case, issues such as tax avoidance pack a bit more punch these days than they used to because of social media. No company wants to be the object of a petition on or to have groups of protesters whipped up on Facebook rampaging through its high street stores. “Never underestimate the power of the media,” says Kinnersley.

As SRI comes of age and develops, it has also become apparent that standards are not just for other people; there needs to be standardisation within the SRI sector itself. There are two principal areas where this is needed.

The first is the labelling of funds on the retail side. In France, there is the Novethic label, in Luxembourg, the LuxFlag Environment Label, and there are rumours of labels being introduced in Belgium and Germany, but there is no European standard.

“What we need is a European label,” says Borremans.

The second area is in the measures of the environmental and social benefits of that SRI brings.

“It’s the missing link,” says Borremans. “There is a consensus to do it but divergence on how to do it. There is no commonly agreed on methodology. It’s impossible to compare one fund manager with another. There is a strong need for standardisation.”

He says that industry will move in that direction “in the next months”. The matter is, in a way, urgent, because the absence of standards opens the door to greenwashing – the enemy of SRI.

Another, perhaps more complex question for this sector – also brought to the fore by austerity – is how it interacts with the asset management industry itself. The industry is part of a financial system that failed and of a financial world filled with offshore centres.

“I don’t think the asset management industry is immune from criticism,” says Kinnersley. “A lot of funds we create are offshore. It’s not necessarily to avoid tax, but there are some issues there.”

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