Environmental, social and governance considerations are very much part of our investment landscape now – and investment managers and superannuation funds are feeling the weight of community expectation that they act as leaders rather than reluctant followers in the fight to cool our planet and improve social outcomes.
This is good news, according to Louise Watson, managing director at Natixis Investment Managers, who believes that investment managers are in a powerful position when it comes to driving change, and should be using their financial strength to confront some of the most pressing environmental and social challenges of our time.
According to the Responsible Investment Association Australasia (RIAA), nearly half of all Australia’s assets under management are invested through some form of responsible investment strategy (RIAA report, “From Values to Riches”, 2017). What constitutes ‘responsible investment’ differs from fund to fund, but the time when environmental, social and governance (ESG) considerations played no role in investment decisions is very much over. The integration of ESG is now not only accepted, but expected, and early initiatives, such as negative screening, have evolved into a much more holistic approach to integrating ESG considerations into portfolio decisions at every level.
The RIAA report goes on to state that the principal driver of the evolution in ESG investing is “demand from consumers seeking investments consistent with their personal values.” In fact, 92 per cent said they expect responsible and ethical investment, and 80 per cent said they would consider switching their super or other investments if their manager engaged in activities inconsistent with their values. These are significant numbers, and it’s no surprise that millennials are named as the segment most likely to act on their expectations that organisations deliver quality and trustworthy responsible investments.
That’s backed up by Natixis research (Natixis Investment Managers Millennials Report 2017) which showed that three in four millennials say it’s important their investments are doing social good, and 73 per cent said they would want to sell if a company in their holdings had negative environmental or ethical issues.
Super funds and other institutional investment managers are listening. Roles such as Head of ESG Risk Management, which would not have existed a few short years ago, are now common, as are dedicated resources in the form of ESG-focused teams and in-depth research. Transparency of reporting is also increasing, as members’ access to information improves. And, in the pursuit of what has been termed ‘relevance investing’, some super funds survey members, usually every two years, in order to better understand member values and interests and therefore align their investment decisions.
Performance and ESG – are they mutually incompatible?
The short answer is definitely not, and investors are beginning to understand this.
The RIAA report reveals a very interesting change in attitudes towards the trade-off between maximising financial returns. In 2013, just over half (54 per cent) of investors preferred an investment manager which maximized returns while also considering the ESG of the companies it invested in, whereas 46 per cent focused solely on maximising returns. In this latest report, published at the end of 2017, almost 70 per cent of investors (69 per cent) want both ESG and returns and only 31 per cent are focused solely on financial returns.
The world is clearly changing, and investors now understand that both ESG and performance are possible. Financial performance is always top of mind, particularly when it comes to achieving long-term goals, like retirement, but investors now expect that this can be achieved in accordance with ESG outcomes. If anything, they expect stronger returns from investments which address ESG concerns. This is backed up by RIAA data (Responsible Investment Benchmark Report 2018 Australia), which shows that ESG funds have performed better than non-ESG funds on average over three, five and ten year time horizons, across Australian share funds, international share funds, and balanced funds.
Innovative solutions to the environmental and social challenges of our time
Where and how we invest can be a powerful force for change because money can effect change in ways that talking can’t. One of the areas where investment is pushing innovation is in the pursuit of solutions to climate change.
Neither financial advisers, institutional investors, wealth managers and millennial retail investors can ignore the impact of climate change and their drive to invest in companies building innovative solutions to address climate change and other social challenges is an effective tool for change. It’s one way in which financial industry can play its role in transforming our current economy into a sustainable global economy in the future.
There are a number of ways in which businesses at the forefront of the push for responsible investment drive change, the most common of which is via green bonds, typically used to fund projects with positive environmental and/or climate benefits.
The first green bonds were issued globally in 2012 and in 2014 in Australia. Since then, Australian public and private institutions have issued over $4 billion in green bonds (Climate Bonds Initiative Green Bonds Market Summary – Q3 2018). While a respectable figure, this is just a fraction of the $21 billion issued globally in 2017 alone. There are now a wide range of issuers and initiatives, green bonds are being used to fund a variety of environmental projects including renewable energy, low-carbon mobility (electric vehicles), energy efficient buildings, and water sustainability.
Green bonds are not the only option available, however. Strategies which reduce carbon emissions and embrace social impact investing are available across equities and infrastructure investment, and funds which offer investors the ability to support sustainable land and ocean management are also growing in prevalence and sophistication. A good example is the drive to reduce the CO2 emissions associated with beef and other livestock production.
The high economic cost of inaction on climate change
There is no doubt that inaction on climate change today will have a significant negative impact on economic growth in the future. The 2006 Stern Report put the cost of such inaction at 5 per cent of GDP, (a figure now considered to be conservative) – and the link between increasing temperatures and output in terms of economic growth is clear.
That’s why it’s hard to justify not addressing climate change, if only for the economic benefits. Collectively investing in solutions through green bonds and other ESG-focused investments will not only help save the planet, but may in fact lead to higher market returns.
Generating energy more sustainably must be considered the first and most important step, and this means investing in energy efficiency and renewable initiatives in order to provide growth opportunities for innovators in this space. Unfortunately, at present, energy efficiency and renewables do not feature heavily enough in most investment portfolios. We believe that early movers on this issue can reasonably expect to disproportionately benefit, compared to those who adjust their portfolios later.
Active management is key
It’s important, at this juncture, to make the point that active, rather than passive, investment strategies are more powerful when it comes to delivering real change. Most major indices are made up of ‘old world’ carbon intensive businesses, many of which are not actively addressing climate change. This means that passive or index investors are exposed only to these companies. Research undertaken by responsible investment manager, Mirova (an affiliate manager within the Natixis Investment Managers multi-affiliate model) indicates that traditional equity and bond indices are made up of companies with a global warming scenario of between 4°- 5° celsius, a level which climate scientists insist would be catastrophic for the planet.
On the other hand, the Paris Agreement on climate change pledged to create a below 2° celsius world and to implement strategies aligned with this. This means taking a long ,hard look at how carbon emissions and environmental outcomes are measured. Moving beyond negative screening is imperative and considering the entire value chain of renewable energy and energy efficiency solutions.
To this end, Mirova has recently unveiled a new climate impact methodology which calculates not only induced emissions, but also avoided emissions on a full life-cycle basis. The data is then translated into a climate scenario indicator at a portfolio level, in order to understand the relative impact of different strategies and re-orient investments. Such an intensive methodology required a great deal of research, back-testing and focus, but it is essential if we are to achieve real change.
Climate change is real
Most of us know that the most recent hurricane season in the northern hemisphere was one of the most devastating in living memory. To paraphrase Jens Peers, CIO of Sustainable Equities and Fixed Income at Mirova, the inconvenient truth is we can only talk about the urgent need climate change and the role ESG investing can play when people are listening. If the only positive to come from the devastation is that more institutional investors take ESG investing more seriously, then we will have achieved something.
Louise Watson is the head of institutional sales at Natixis Investment Managers.
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