Expanding the ESG horizon

— 1 minute read
While ESG strategies have been incorporated into mainstream asset classes, investors are now looking to include these principles in alternative assets. Clearway's Joseph Fekete assesses the trend.
Investors globally are starting to broaden their definitions and expand their opportunity set by seeking to identify environmental, social and governance (ESG) investing options in the alternatives space - specifically private markets and some non-traditional listed equity assets. Investors in Australia and New Zealand are also beginning to embrace this trend.

Further, investors in the region are increasingly thinking about whether ESG can be more focused on strategies creating positive and explicit outcomes (regardless of motivation) as opposed to correcting negative behaviours. Below are examples of a few strategies that have been attracting attention in Australia and New Zealand

Property redevelopment strategies have a distinct recycling aspect and can incorporate acquisition, repositioning (possibly involving remediation of contaminated sites and/or reducing carbon footprint) and redevelopment of otherwise under-used real estate. They may even help to transform communities negatively affected by the demise of industries long relied upon (witness the gradual demise of the United States manufacturing industry).


Double and triple bottom line private equity and property funds are becoming popular in the US. Typically these funds have invested in start-up businesses and real estate in low-income communities. Their first bottom line is to generate acceptable risk-adjusted return for investors; their second is to achieve positive social and economic outcomes for the communities directly involved; and their third (where applicable) is to hopefully achieve these goals in an environmentally sustainable manner. Clearly, there is some overlap with the redevelopment strategies mentioned above, although for those strategies the second and third bottom lines are not their raison d'être.

Beyond private equity, the growth of the catastrophe bond market post-Hurricane Katrina is helping to develop a more efficient catastrophe insurance industry (bond issuance has been dominated by earthquakes and windstorms), enabling insurance companies to better price policies - with the end result being more realistic and affordable premiums and greater coverage for the insured.

Clean(er) energy-themed strategies such as water, wind, solar and carbon (reduction) straddle public and private markets and both physical and trading strategies. The nature of the underlying businesses encompasses production/sourcing, distribution/delivery, technological development, treatment/refining and myriad other possibilities. Timber funds focus on sustainable forestry but also tick boxes on carbon reduction. Note also, the water theme is not limited to energy production, but also the sourcing and transportation of uncontaminated water for irrigation and human consumption.

The above are only provided as examples. Improving the economic circumstances of the San Francisco Bay Area, recycling US automotive manufacturing properties and effecting more extensive and efficient catastrophe insurance coverage for the US west coast may not be uppermost in the minds of regional superannuants. While these investment strategies have developed and grown in the US in the first instance (as one might have expected), the issues/challenges that have provided the impetus are global in nature. To date, regional investors looking at these areas have, for the most part, focused more on broadly similar opportunities likely to have an impact closer to home.

It is not essential to believe in the concept of ESG as an alpha source in order to believe such 'alternative' ESG strategies can deliver high returns. While the development of some of these strategies may have been driven by ESG concerns, fund managers have embraced them in order to satisfy investor demand and with their primary focus being risk-adjusted returns rather than the greater good (though that may also be a key motivator).

However, these strategies are not considered mainstream. Investors perceive them as expensive and illiquid, and recognise they can introduce valuation biases and heighten operational risks. On the other hand, they potentially offer attractive risk-adjusted returns and, in most environments, low correlations to traditional asset classes.

Investors in Australia and New Zealand are enthusiastic about the possibilities for effecting positive change and much work has been undertaken in relation to traditional listed equity and fixed income asset sectors. In seeking to effect change, our observation is that more and more regional investors are expanding their ESG horizons by embracing less traditional investment opportunities.


Expanding the ESG horizon
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