INSIGHT by Pras Gengatharan, Investment Specialist
2021 is the year of Sustainability and ESG investing, and investment managers are taking turns in announcing their new standards, pledges and approaches to further the movement. By now, we have seen or read many examples of how making sustainable investing integral to the way we manage risk, construct alpha-generating portfolios and improving the way stewardship is conducted, will lead to better outcomes for investors.
Reporting Standards and EU Regulation
While some of the larger investment houses are looking to their peers for guidance and inspiration, there is a renewed sense of purpose in addressing the cause and effect of environmental issues in investment portfolios. This focus is a result of changes in reporting standards and EU regulation, which highlight the non-financial elements of risk, and forces the industry to further improve its ESG integration through transformation and incorporation for all of its investment offerings. Add to that, the increasingly measurable challenges of the ‘S’ by way of recently felt problems, such as pandemic response, human rights abuses or forced labour, and you have yourself a cornucopia of topics that concern investment managers.
ESG and the Investment Research Profession
One of the bigger cultural challenges is the harmonisation of ESG and a mature investment research profession that traditionally may not have attributed sufficient significance to aspects external to the core of their investment cases, such as climate change.
Jeroen Huysinga, fund manager and MD at JPMorgan Asset Management, recently retired from his duties and reflects on the changes to the industry throughout his long-storied career in managing equities portfolios:
“When I started as a professional investor 30 years ago, there was little awareness of the significance, whether in a financial or a broader societal sense, of many of the factors which are now labelled ESG. As the world has become globally interdependent in an economic, political and cultural sense, perceptions around issues such as climate change have emerged. As corporates have globalised their operations, the need to formulate ESG based assessments has risen immeasurably, not just because of the ‘demand-pull’ of more socially conscious investors and broader ethical imperatives but because of the demonstrable financial logic of investing in corporations which genuinely get it.”
Do companies “walk the talk”?
He further cautions to differentiate between companies who pay lip service to changes in regulation, accounting and reporting standards and those who genuinely ‘walk the talk’ with particular focus on pre-empting evolving standards. Sustainability scores ought to be considered in the same vein as credit analysis.
Sustainability is an essential element of the toolkit
“Sustainability is integral to the investment process. Experienced research analysts of the future will require expertise in sustainability as an essential element of their professional toolkit. Separation cannot be anything other than a relatively short term, transitional feature.”
Senior portfolio manager Jeremy Kent, who recently announced his departure from Allianz Global Investors where he co-managed the Global Sustainability Strategy, contemplates the generational shift of wealth to a younger, more socially conscious investor profile:
“Managing a Sustainable & Responsible investment strategy has meant that this shift has led to a significant increase in interest in the investment approach. This entails a significant amount of education and ‘hand-holding’ for clients in what distinguishes different approaches and what matches their needs best. One tangible example of the generational shift is the topic of exclusions where currently these may include activities such as the sale of tobacco. However, younger investors demonstrate an inclination for exclusions such as animal husbandry.”
Jeremy, who is pursuing a new challenge with the Sustainable and Impact Investing team at NN Investment Partners, points out that the ability to identify these nuanced preferences, coupled with the surge in client interest, has led to a dramatic rise in competition within the industry. There is an appetite for new products but also an opportunity to significantly repackage and classify existing investment approaches.
The mind of the portfolio manager
One of the questions you often hear institutional clients ask their investment managers is “What is the portfolio manager thinking?”, and it has taken on a new meaning in recent years. It is a valid question as clients rely on their investors’ deep expertise to understand challenging markets yet identify opportunities to grow wealth responsibly.
“I have spent more time thinking about the positive outliers in this respect. Previously I viewed ESG evaluation as really the identifying of companies I did not want to own because of the risk,” said James Sutton, who works for a major money manager.
Positive outliers are an easy win for many portfolio managers, as these companies have strong sustainability practices and in turn, maintain brand loyalty with their customers. One particular observation is the lower cost of capital attached with stronger ESG credentials but also more generally, the proliferation of data that is making it more and more necessary for investment houses to develop in-house capabilities.
“I think it is inconceivable for any client portfolio to be run without regard to ESG issues. It should always be a consideration for any investment. It will come down to client preference and whether they want merely ESG integration right through to impact investing solutions. In my opinion, it is necessary to develop a proprietary framework which combines some of the output from external providers with the insight from in-house research analysts who commit to active ownership.”
ESG: Product strategy vs. general investment thesis
While there is also a trend among some investment houses to treat ESG as a product strategy rather than to integrate it as part of the general investment thesis, investors are attuned to the acute, short-term needs of existing research frameworks. Jeroen, who is currently pursuing an MSc in Charity Effectiveness, thinks that ESG should not form a separate strategy or specialist theme.
“I can understand why investment firms would wish to keep this area separate for product differentiation or reasons on revenue potential, but longer-term, this all becomes one. It is also important to emphasise that corporates who do not understand this shift will face higher costs of capital. They will see lower valuations and levels of market stigma which will become increasingly difficult to shake off.”
ESG, good governance and competitiveness
Governance and leadership from the top are at the core of this integration and any enthusiasm to change investment approaches will fall flat without it. Investment firms increasingly use the threat of divestment to set the tone and chart a meaningful pathway to improving a corporation’s sustainability footprint. There is evidence that poorly governed companies who do not address key environmental issues e.g., will notice an erosive effect on its competitiveness. Good governance merely puts a company on a level playing field with its competitors. Outcome-oriented, purposeful engagement with corporates can influence their behaviour and have a material impact on a company’s performance and in turn, deliver returns on your investments.
Pras Gengatharan, Investment Specialist, previously 13 years with JPMorgan Asset Management as VP in the International Equities Group and two years in a treasury position with The Law Debenture Corporation.
| All opinions expressed are those of the author. investESG.eu is an independent and neutral platform dedicated to generating debate around ESG investing topics.