A panel of experts from the investment community discuss the latest developments in sustainable investments
07 JUNE 2018 | SIMON HOWARD, EDWARD MASON, SARIKA GOEL & BRUNO BERTOCCI
Industry representative, Simon Howard (SH) chief executive, UK Sustainable Investment & Finance Association (UKSIF)
Asset owner Edward Mason (EM) head of responsible investment, Church Commissioners for England
Investment Consultant Sarika Goel (SG) responsible investment consultant, Mercer
Asset manager Bruno Bertocci (BB) senior portfolio manager and managing director, UBS
How can institutional investments be applied to help create a more sustainable world? There is growing recognition that, not only can this be achieved, but it is a core component of what constitutes best practice from an investment perspective. Considering environmental, social and governance (ESG) issues within the investment decision-making process helps to provide enhanced investment returns, reduces risk and also has a positive impact on the world. This focus on 'ESG integration' is rapidly gaining traction, which can only be good news for everyone.
The Principles for Responsible Investment (PRI) have ESG at their heart. Over 1,800 institutional investors from around the world have signed up to it. The launch by the United Nations in 2015 of the Sustainable Development Goals (SDG) for tackling world problems has provided an extra focus for what PRI means in practice. There is also growing interest from regulators to ensure ESG factors are considered by investors.
Representatives from the investment community recently met to discuss the latest developments in ESG at a Sustainability Summit in London. We invited four of the speakers to form an expert panel and provide their thoughts to some questions we posed:
What have been the main changes over the last five years?
SH: I think the main change is growing recognition on the part of many professionals, regulators and institutional asset owners that there are material financial risks and opportunities in sustainability.Things like the Paris Climate Accord and the two Law Commission reports on the role of pension trustees in ESG investing have both reflected and driven this change.
There is no doubt that UKSIF finds a more ready audience compared to five years ago.
EM: The Church Commissioners' pursuit of sustainable investing goes back many years. We established our sustainability-themed global equities mandate in 2008; today it is our largest global equities mandate, accounting for nearly 5% of our total portfolio. One particular change stands out for me over the past five years - the growing influence of shareholder engagement on sustainability issues with companies, particularly on climate change. We have been at the forefront of this, particularly through our use of institutional-quality shareholder resolutions. During 2015-2017 we have co-filed resolutions on climate disclosure at BP, Shell, Exxon, Anglo American, Glencore and Rio Tinto, which have all passed. The UK resolutions were recommended by the companies' boards, but not the Exxon resolution - nonetheless it passed with 62% shareholder support, a landmark moment.
SG: The international focus on climate change and UN Sustainable Development Goals since 2015 has been a key driver for the heightened interest by a much larger group of asset owners and asset managers, who are actively focusing on these revenue opportunities. From a risk perspective, the increased focus on regulations is driving asset managers to further think about ESG integration. This is leading to new product development across a range of asset classes.
BB: The primary change has been the realisation by asset owners, professional investors and individuals that recognising material sustainability factors enhances the investment decision-making process. Such factors are markers of internal culture and behaviour that ultimately affects the financial results. For example, there is a correlation between high and low accident rates in factories (normalised by workforce size) that is predictive of product quality, which impacts the brand and ability to price higher. Many academic studies show that shareholders have negative views of companies with poor governance characteristics. The recent US Department of Labor ruling on the fiduciary duty of a financial advisor helped change the equation as well, since it places ESG alongside other material factors that need to be considered.
What are your top risk priorities?
SH: Our concerns are rather contradictory. On the one hand our members are worried that there will be too great a focus on climate at the expense of other environmental issues, as well as social and governance issues. On the other hand, we recognise that the sheer breadth of sustainability issues (such as pollution, intensive food production, human rights, tobacco and many more) can make approaching sustainability appear intimidating. Presenting a well-argued case that the traditional investment approach is now likely to produce poor returns is our core priority.
EM: We noted the IFoA's risk alert last year on climate change. We are very focused on navigating prudently the investment risks and opportunities associated with the transition to a low-carbon economy. In January 2017, we launched a new initiative in collaboration with the Environment Agency Pension Fund and Grantham Research Institute at the London School of Economics - the Transition Pathway Initiative (www.lse.ac.uk/GranthamInstitute/tpi/). This tracks progress in the transition to a low-carbon economy of the largest companies globally in the industrial sectors most exposed to greenhouse gas emissions. It is a free resource, now supported by investors with over £5trn of assets, and is a great tool to identify those companies in a portfolio which are, or are not, managing climate change transition risk.
SG: We are looking to help a broader range of our clients on this journey, in addition to continuing to work with the clients who have demonstrated leadership in responsible investment over the past decade. The key driver is climate change as a systemic risk, but also other increasingly connected, whole-of-portfolio risks that can't simply be delegated to investment managers. We are working with clients across strategic asset allocation, portfolio construction and manager appointment decisions. We also help asset owners through the use of our ESG Ratings, which indicate how well the overall portfolio is being managed from an ESG perspective.
BB: Maybe I would modify your question and note that risk is symmetrical. We think of sustainability factors as having both negative and positive characteristics: they can point to companies with seemingly hidden risks (such as a history of regulatory incidents, or inability to retain key talent) or the opposite, hallmarks of superior business models with strong innovation, safe factories, good supply chain controls, and more. Think of these factors as operating metrics that drive financial results.
What do you see as the top opportunities by theme and asset class?
SH: We think sustainability should be (and can be) integrated into the management of all asset classes.
EM: We have gone into sustainable forestry in quite a big way over the last few years. In 2010, forestry was not even an asset class we invested in, but by the end of 2016 it accounted for over 4% of our total portfolio. As an endowment with a long-term approach to investment, we find sustainably managed forestry a very attractive asset class. Also, we are finding that we can add value, and further sustainability benefit, by hosting commercial wind and solar farms on our timberland, just as on our rural land.
SG: There is no particular emphasis on any one theme, as asset managers develop strategies around multiple themes linked to the low-carbon economy, as well as to other sustainability challenges. By asset class, we continue to see the majority of opportunities accessed via private markets, real assets, and listed equities, but there are interesting themes emerging in fixed income, such as green and other social impact bonds which we believe may gain interest and demand as investors become comfortable in how they verify the bonds for green and other social credentials.
BB: The biggest change is taking place across the entire industry, with a growing focus on the social function of asset management and pension fund management. The discussion has shifted beyond the creation of investment returns in the abstract to include how the returns are being generated. Increasingly asset owners want to know if the companies in their active portfolios are making money and making the world a better place. It's a bit like food... 20 years ago we ate what was in front of us, now we ask: "Is this organic lettuce, what about genetic modification?" A lot more questions and interest than calories alone.
What changes do you expect in the next five years?
SH: UKSIF expects sustainability to be increasingly mandated by law and regulation. We expect it to become integral to the vast majority of fund management methods and to be considered far more in banking. Our opinion polling already suggests public demand for sustainable finance is growing, and we expect this to continue and to influence defined contribution pensions.
EM: We engage with all our investment managers across all asset classes on how they are incorporating ESG issues into their investment decisions and investment ownership practice. We have seen our managers' thinking and approaches move forward significantly since we instituted our comprehensive Responsible Investment Framework in 2015. I expect this trend of increasing ESG incorporation across the investment world to accelerate. Growing environmental and social pressures are making ESG factors ever more financially material.
SG: Sustainability hasn't quite become standard yet but the direction of travel is clear, with a continued emphasis on ESG integration, but also a much greater focus on positive impact measurement. We are seeing more incorporation of ESG specialists into investment teams, so the idea of a separate ESG team is closer to disappearing (although it is not likely to disappear completely within five years). Clients of various sizes are increasingly interested in sustainability themes, and we have developed sustainability-focused private markets and listed equity funds for our delegated client base to access these long-term trends. We expect regulation and the visual impacts of climate change to be strong drivers for change in the investment industry.
BB: I expect to see a mainstreaming of everything I mentioned earlier. I also expect to see a reporting regime (led by the Sustainability Accounting Standards Board) that parallels what we saw with the normalisation of financial reporting data on a global basis. I think sustainability data will be reported similarly, in financial reports and on a more coherent basis.
Who is responsible for influencing these changes?
SH: We would like to think UKSIF's work has played a part in influencing many players and that we will continue to do so. We were delighted that news of the IFoA's intention to issue a risk alert on climate change came at our Ownership Day event last year.
EM: Our philosophy is that ESG is everyone's responsibility. I'm here to support the investment team and ensure consistency, but every member of the team is expected to incorporate ESG issues into their selection, appointment and monitoring of investment managers - or, in the case of our in-house property assets, to incorporate ESG issues into their investment decisions and asset stewardship. Leadership is vital at any investing organisation, but with the priority the Church attaches to environmental stewardship, we are not lacking leadership and encouragement.
SG: We all have a part to play. As consultants we recognise that, while we in Mercer's responsible investment team have led the way for a long time, this is no longer enough and our consultants increasingly need to play their part in taking our advice to asset owners. Our manager research team also has a part to play in how they differentiate strategies based on the extent that ESG is integrated within investment decisions. Asset owners have an important role for their beneficiaries and appointed asset managers should be focused on supporting these asset owners in meeting their objectives. And of course, the context set by regulators/policymakers and consumers/beneficiaries all contribute to how far we can each go in making sustainability standard.
BB: Asset owners and regulators have an important role, as do the leading asset managers. I also see high net worth and other individuals pushing for ESG integration as well.