The Changing World of Sustainable Investing: Your Questions Answered
By Phil Wellington - November 23, 2022
As part of the 'Meet the ESG Investment Influencers' series hosted by Professional Adviser and Fidelity International, PortfolioMetrix's Investment Analyst Phil Wellington answers key questions about the increasingly complex and changing world of sustainable investing.
We've compiled Q&A responses from Phil's interview with Tom Higgins of Professional Adviser below.
What are the biggest challenges you’re facing in the ESG space and how are you dealing with them?
I think the biggest challenge is managing investors’ expectations. Our Sustainable World portfolios have a dual mandate which aims to achieve the best risk-adjusted returns but with a focus on a positive environmental & societal impact – but this can mean different things to everyone. We outlined this and many other ESG-related topics in our Whitepaper ESG: Everything you wanted to know but were afraid to ask.
These portfolios consist of Impact, ESG and Sustainable funds, all doing something slightly different. We need to effectively communicate what these portfolios are and, more importantly, what they aren’t. We do that through a comprehensive client guide which gives a summary of all funds held within the portfolio and their ESG characteristics
How important is it that asset managers use their vote at company AGMs to push for change?
Using your vote is a vital part of Stewardship. In our Responsible Investment Policy, we set out some guidelines around how we invest client money across the company. Part of that states that we only use funds that demonstrate adequate Stewardship.
That being said, on many occasions, individual or group engagement on a topic can have a very big impact on the direction of change within a company. And sometimes having a dedicated group discussing this topic with management, that is open to feedback, can often be the catalyst for a much greater swing in corporate direction.
So voting needs to be carried out alongside other methods of Stewardship.
How are asset managers progressing with their commitment to the move to net zero?
Net zero was always going to be a slow-moving goal. Change can’t happen overnight and it also needs global cooperation, which doesn’t necessarily seem to be forthcoming at the moment.
But index providers have been creating low/net zero carbon indices or Paris-aligned indices for a couple of years. And we are now starting to see funds launching that either track those indices or take an active approach to align their portfolio with the Paris Agreement.
Some good groundwork has been laid, but 2022 has highlighted that the global reliance on oil very much still persists.
What do you see as the key regulatory issues this year and how are you addressing them?
Although not yet part of formal regulation, the Consultation Paper on the UK’s Sustainability Disclosure Requirements was published in October this year. This is set to be the key piece of regulation in the Sustainability space for the UK and is going to define the scope, depth and breadth of disclosure requirements as well as a framework around product classification & labelling.
It will not come into force this year, but it will certainly impact the work and thinking of the UK financial services industry for the remainder of this year.
Biodiversity has increased in prominence. Are asset managers doing enough? Is there enough focus on nature-positive investing?
Things like Blue Planet are extremely useful for raising the prominence of issues with the general public. And I think that has been partly responsible for the increased interest in ESG investing in general.
That being said, having graduated as a forensic scientist, I know that the ‘CSI effect' is a very real thing. The public watches a fantastically produced program, which can then put some unrealistic expectations on thinking – e.g. 1 program-based CSI actually does the job of around 8 or so dedicated experts; likewise, an investor saying they want no harm done to wildlife in the managing of their portfolio, is practically next to impossible to achieve.
Despite its rising interest, there is not really much on offer in the fund space on this – perhaps because it is a little too niche, but certainly can and does form part of a wider investment opportunity alongside other themes. Additionally, a number of asset managers at a firm level are making more commitments to this, regardless of portfolio investments.
The debate around divestment is raging on. Is divesting allowing less conscientious investors to buy in? Or conversely, is there a risk of investors not divesting but not engaging either?
Equity investing has always been seen as one that has less ‘additionality’ to it. If you sell, someone else will always buy – the nature of markets. Whilst new fundraising/fixed income is more intentional. I think we can leave that discussion for another day, but…
Once invested, engagement (rather than divestment) should almost always be the first port of call at the first sign of uncertainty. This can unearth some very valid reasons/explanations for a particular scenario arising or insights as to how it is being dealt with.
If this step begins to falter after a reasonable time of engagement, then divestment might be the most sensible option.
Globally there are almost $4trn in sustainable assets. Do you think flows will steadily increase or are they likely to plateau?
What defines ‘Sustainability’ is, I think, the key to answering this question. The exact amount of these assets varies vastly from report to report. But if I look at the Global Sustainable Investment Alliance, they have been reporting every 2 years since 2014 and although assets have increased each period, the story by region is interesting.
In Europe and Australia, Regulatory change to tighten definitions actually resulted in decreases in assets managed sustainably in these regions between 2018 and 2020. So as regulation tightens more globally we may see a flattening in the near term.
Further out into the future, I think more and more money will begin to be managed more sustainably (driven by regulation, client demand and asset manager offerings) and the trend will be heading upwards in general from here.
How important are human rights and social issues in your investment decisions?
I would argue that good human rights are more of an indication of strong governance and that is something which all portfolio managers should be looking at and analysing for their underlying companies. Often those with poor human rights records will not only be bad for society as a whole but also be poor allocators of resources/capital and thus also poor shareholder returns.
Social issues are much broader ranging. Those companies that are trying to even the imbalances there tend to come out on top. For example, a paper from 2011 by Alex Edmans showed share price performance of companies with high employee satisfaction significantly outperformed industry benchmarks. Also, a lot of the SDGs have some orientation towards rectifying social imbalances (no poverty, quality education, gender equality, and reduced inequality to name a few) and will help us to move towards a much more sustainable future.
Should asset managers have a limit on portfolio emissions?
Perhaps a limit on emissions is a bit of a blunt measurement tool. You only get change from the biggest offenders starting to make a shift towards being lower emitters (the materiality of the impact is much higher on the globe). As such, those companies should be rewarded for their efforts by investors and be allowed into portfolios by managers who see their value from a forward-looking perspective.
The classic example would be Orsted, who is the poster child of many ESG portfolios but was previously one of the world’s larger managers of oil & natural gas resources. In 2009, they committed to shifting from 85% fossil fuel-based activities to 15%. They now have 90% of their energy generated from renewables, targeting 99% by 2025 as well as a fantastic annual sustainability report.
By insisting on a portfolio emissions limit, the next Orsted might be excluded from portfolios/investments and hamper its ability to change the world with a portfolio emissions limit.
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