ESG which stands for ethical, social and governance investing has been around for a long time although investment managers have taken the concept more seriously as more activism and information about companies has risen in society. With the announcement that the Co-operative Groups pension scheme would put £323mn into L&G’s investment Management Future World fund to align their member values, it follows that the £6trillion pension industry, would sit up. One survey the Co-op did said 60% wanted to invest into companies with clear climate change, executive pay and diversity policies.
However, the demand isn’t satiated, powerful investors are calling upon their investment managers to deliver more: more innovation, more impactful products and more measurement.
Does ESG live up to the hype?
In our last update ‘ESG sustainability and the Greta effect’ we discussed how the younger generation were leading the movement towards ethical, social and governance (ESG) investing but that the lack of a standard definition was creating confusion for private and institutional investors.
At this point, we are no closer to one definition, but frameworks have emerged. For example, there is the S&P500 ESG Index, the MSCI ESG Index, and the FTSE ESG Index Series. However, Simon Black, head of investment management at Dolfin says, “For investors it is still confusing. They want to know which is better so what’s more ESG? The challenge for us is how do we quantify that in a way that makes sense?”.
One solution that organisations have adopted is to integrate into their measurement the UN’s Sustainable Development Goals, explains Ian Rumens. “These aim to address everything from climate change to poverty eradication to equality of opportunity and the UN wishes to achieve them all by 2030.”
Despite not having a single definition of ESG, the market is moving forward at a rapid rate. One of the reasons for which could be that those who invested in funds have been richly rewarded in 2019 with returns of up to 32% according to Morningstar data.
Yet, there are arguments that these investments aren’t as straight forward as they seem. For instance, The Wall Street Journal announced in November 2019 that eight of the 10 biggest US sustainable funds invested in oil and gas companies.
ESG or impact? What’s the difference?
Perhaps, it’s partly due to the confusion that investors’ attention has now been grabbed by impact investing. “Clients want to know what they are investing in, whether it will have a positive impact on society and what difference it will make”, explains Simon.
While ESG and Socially Responsible Investing (SRI) looks at ‘negative screening’ which means they exclude companies or industries as the Quaker’s in the 18th Century did, refusing to invest in the slave trade; impact investing, considered as a more sophisticated lens now is focused on positive screening which looks at companies using ESG data to improve. So, an investor concerned about global warming would look at their carbon risk ratings to select the best company.
Victoria Blackburn, senior manager at JTC Private Office, explains, “Visually it was a bit like two ends of a magnet whereby investors initially repelled anything that they didn’t like for social or ethical reasons, thus excluding it from their investment criteria. Now we hear more about ‘thematic’ investing, which is when the magnet actively attracts investment (positive screening) and particular stocks are sought out and added rather than excluded from a portfolio”.
She adds, “the easiest way to think of it is like a political spectrum”. On the far right is conventional investing focused above all else on making financial returns, moving along towards the centre comes ESG which seeks financial returns with some social impact, then in the centre is SRI which looks for a balance between financial return and positive social outcomes, and then further left is impact investing which focuses on social outcomes first and then financial returns as a secondary outcome until finally we reach the far left, where philanthropy sits focused solely on positive social outcomes.
Her advice to those getting confused is to ignore the labels for now. “What one needs to think about is ‘do I want a financial return from this and if so, how much?’ ‘Is that more important than the social impact or vice versa?’ Getting this balance and working out what is important and why to a client means they can make more informed choices and I would encourage any client to ask probing questions to ensure that what they invest into is being managed to deliver the returns that are important to them, financial or social.”
Unfortunately, impact investing is also not without its challenges. The first is meeting demand. Despite investors looking to invest only a small percentage to these goals, perhaps 10-15 per cent, demand outweighs supply.
Impact investing is for the most part, bespoke for each client. Simon explains “one of the key difficulties is the lack of liquid investments, many tend to be on the venture capital side which means high risk and start-up’s”.
"Dolfin’s framework, instead, is focused on generating positive outcomes, which is the key differentiator from ESG investing. It aims to emphasise the fundamental dimensions of impact investing: intentionality, additionality and measurability. We follow the general guidance provided by organisations such as GIIN (Global Impact Investing Network) and IMP (Impact Management Project) and utilise both quantitative and qualitative impact indicators and KPIs across different dimensions of impact intentions”, added investment associate Anny Giavelli.
“For example, if we are looking at financial inclusion, we research, understand and measure the level of access to financial services for previously underserved segments to identify "who" is the beneficiary. We then need to understand how companies improve the quality of financial services by measuring product affordability, convenience, depth and breadth of reach to assess "how much" impact. The main challenge is data aggregation, which is burdensome."
Nothing is more powerful than an idea whose time has come
One area of impact investing on the rise is climate-related investing. One example is the work being conducted by the Guernsey government. Launched in 2018, the Guernsey Green Fund was the world’s first regulated green fund product. Under the rules, 75% of a fund’s assets by value must meet specified green criteria. Permitted investment areas include renewable energy, efficient energy generation, energy efficiency, agriculture, waste and wastewater and transport. The rules use an internationally-recognised set of green criteria, developed by the joint finance group of multilateral development banks.
Stop and smell the roses
To date, the regime has a combined AUM of $5.5billion. “That compares favourably to the UK where the UK Green Finance Institute claim £10bn in listed funds.”, explains Dr Andy Sloan, Chairman of Guernsey Green Finance.
Andy describes the Guernsey Green Fund regime as “sustainable finance, both ESG and impact investing, following a proper process for ensuring investments are sustainable, and directing capital and investment to climate change mitigation”.
Big green plans afoot in Guernsey
The next steps for Guernsey Green Finance include leveraging their leadership into the private equity and private capital space. “We're publishing the Green Principles for Private Equity shortly, and looking to publish a framework for private capital this summer. Broadly, it's important to guide owners and advisors of private wealth, like family offices as to gold standards as they aren’t under any regulatory oversight. We will offer support and guidance through a framework of how to invest sustainably, advising on what principles to follow, what factors to consider, and what metrics and measurements may or may not be relevant”, said Andy. “It’s about creating an ecosystem. We’re building a movement, to encourage a sustainable mindset”, he added.
I will always love EU
“Policymakers are keen to provide clarity on what sustainable investments are by creating an EU-wide classification system, akin to the Taxonomy Regulation, to provide a common language to identify economic activities that can be considered environmentally-sustainable”, said Matthew Baker, Partner and Christine Ormond, Associate Director at Bryan Cave Leighton Paisner.
This Regulation is expected to come into force from summer 2020. “Whilst the rules do not themselves establish a label for sustainable finance products, they set out criteria for public measures or standards for financial products or corporate bonds offered by issuers and other financial market participants which are to be considered environmentally sustainable”, he explains.
Marketing and green washing
The goal is to create greater transparency for end-investors and allow better comparison between products and reduce opportunities for “green-washing”, they added.
“We expect this EU-centric taxonomy to become the global language of mainstream impact investment. However, there is scope for it to be expanded and developed beyond environmentally sustainable activities, to cover other sustainability objectives, such as social and governance issues. In our view it is still important to be able to differentiate between fund products, in order that investors can better understand and compare them and therefore use the information available to them to make a more informed investment decision”, said Matthew and Christine.
Covid19 and the Coronavirus impact for investors
At the time of writing, around 20% of the global population is currently under lockdown due to the coronavirus. A public health crisis, so I asked what effect will this have on impact investing?
Simon responds, “there may be more impact investing interest within the healthcare sector”, while Andy considers “Covid-19 might see a rapid increase in people looking to invest sustainably as people reassess their priorities”. “There will be a tipping point of money looking to sustainable investing. Some will argue to use carbon fuels to get the economy going again, others will say let’s use it to wean ourselves from this carbon need”.
Values will drive investing as Covid19 reveals new champions
Alexander Rhodes, Managing Associate in Mishcon Private believes that: “The interjection of the COVID-19 pandemic has wholly changed the narrative. Today, we find ourselves having to adapt to totally new ways of living and working, watching socio-economic systems around us change, perhaps forever. Every country in the world is facing unprecedented challenges. The most important outcome of this crisis is likely to be an urgent reappraisal of our values: as a global community, as nations, as businesses, as individuals. It is this, more than anything else, that will determine in whom, for what and how we choose to invest for our futures."
Victoria feels it might have the opposite effect for the time being but says that isn’t a bad thing. “Getting a return shouldn’t be seen as being ‘greedy’, if one makes a return it means there is more to invest again and again. The old proverb, give a man a fish for a day and you feed him for a day; teach a man to fish and you feed him for a lifetime, it’s all about balance”.
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