Show 90 – ESG Investing – The Practical Realities – Part 2
CIPR members receive 5 CPD points and PRCA members receive 10 CPD posts for listening to this podcast if they log it at their respective CPD programmes.
The second of our two episodes recorded in partnership with CFA UK at their conference on the topic of ESG Investing and the associated practical realities, where we spoke to a number of the speakers from the event.
ESG is currently facing growing demand yet in many ways the sector is still in the early stages of establishing best practice. So, CFA UK’s conference covered many of the practical realities of how to effectively measure, score and improve the implementation of environmental, social and governance factors across all asset classes.
In Part 2, we caught up with:
1/ Professor Elroy Dimson, Chairman for the Centre for Endowment Asset Management at the Cambridge Judge Business School, part of the University of Cambridge
2/ Faith Ward, Chief Responsible Investment Officer, Brunel Pension Partnership
3/ Fadi Zaher, Head of Index Research & Development, Legal & General Investment Management
4/ Will Goodhart, Chief Executive Officer, CFA UK
Our first guest on this second episode from the CFA UK ESG investing conference was Professor Elroy Dimson, Chairman for the Centre for Endowment Asset Management at the Judge Business School at the University of Cambridge.
Professor Elroy’s session at the event was on the topic of good practice in ESG stewardship and engagement and he was sharing his research findings on active ownership. He explained that he had worked on active ownership jointly with two colleagues, Oğuzhan Karakaş, University Senior Lecturer in Finance at the University of Cambridge and Xi Li, Associate Professor at London School of Economics and they looked at the extent to which engaging with companies can be a worthwhile activity, not only in terms of accomplishing change, but what its financial consequences are as well. Their findings were published in the Review of Financial Studies.
Professor Elroy said that the bottom line of the findings was that, looking at the history of a major asset owner who engages with US companies, that not only were there successes in terms of achieving those objectives, but this was repeated as good news in the financial industry in the sense that stock prices of companies that were engaged, where the engagement was successful, went up and relative to the market, those engaged where there was no success did not decline, they just performed neutrally.
Since their study was published in 2015, Professor Elroy said that two themes have become important:
- active ownership, if done well, can be financially worthwhile
- what the ingredients are for performing well as an active owner, which are:
- working with others who share the same objectives (the firm that had given them their data set had worked extensively, not only with other investors and asset owners, but also with other groups like Greenpeace, WWF)
- the importance in targeting companies for engagement, of them caring about their reputation.
Therefore, it’s companies who are consumer facing, who are more receptive and who are more likely to change in the way that that dialogue is leading.
Professor also talked about his work around coordinated engagements, which he said came out of their study of active ownership, which had revealed the importance of working with others to achieve common objectives. He said that the principles for responsible investment made available the entire dataset of all of the coordinated engagements that have been undertaken by PRI signatories in a very large number of countries and with a very large number of target companies, and it becomes clear that having a coordinated approach makes it more likely that the objective of that dialogue will be successful. He added that it also makes it clear that the structure of that engagement is important and in particular, having a lead investor who is from the same country as the target company, for engagement and having supporting investors from all around the world, increases the likelihood of success quite substantially.
Professor Elroy said that the ‘doing well by doing good’ story is one in which you try to ensure that companies behave in a way or produce products which are appropriate from the thought to be good. He said that it does have an impact and companies that are unattractive (he gave tobacco companies as an example), can end up as a result of those sentiments with their price being depressed. If their price is depressed, he said that you can expect higher returns from those companies and so, there is the paradox that if you are successful in influencing companies and the stock price of those companies goes down, the future returns will be higher. He said that some people talk about a ‘sin stock premium’, i.e., if you are willing to invest in the sin stock, then you might expect higher returns.
The evidence that Professor Elroy said they had compiled is one in which you can achieve outperformance by changing companies for the better. So that journey from more poorly behaving to a better behaving company can be accompanied by an increase in the price. However, he added that a higher price for a company means that future returns will be lower. He thinks this is entirely consistent with pensioners and others thinking about ethical issues. He said that there is no ethical issue if you’re simply deciding, do you want to make more money or less money? The ethical issue is when you decide that there are certain sorts of companies you’d like to hold and others you would not like to hold, and that there may be a sacrifice in making that choice of companies that you like. He thinks that for most people though, the journey, the impact and so forth is in the hands of investment managers and that very few are actually interacting with companies that they invest in in a way which would affect change.
Faith believes that ESG should be part of an integrated approach to a portfolio. She said that one of the parallels she has used before is in making an investment decision to invest it in a company is like crossing the road – you’ve made that decision and as you cross the road, you look left and right, see if there’s anything that’s actually going to knock you over in terms of that journey. And that’s how she sees the environmental social governance risks. Is there anything that is going to disrupt that plan of action to invest in that company that you should need to be aware of before you actually make that decision – before crossing the road? So, it’s not a separate style of investing, it’s just a whole series of issues that should be considered when looking at a company to see if those will have a potential impact over the timeframe in which you intend to hold that particular asset, which could be a company. a piece of property or anything, so it applies to all asset classes.
At Brunel, Faith looks after the pensions of those who have worked in the Public Sector for much of their lives, primarily in local authorities and as those people have given their lives to public service, Fait thinks that they’re very aware perhaps of the environmental, social and governance issues that perhaps come with that because they experienced those at first-hand in the nature of what they’re doing, either whether that be in social services or dealing with environmental issues, she thinks they have a higher level of awareness [of funds being used for good], perhaps more historically, than the wider population. Faith said that they are all very interested, as well, to ensure that the financial returns are there, and she thinks that’s also a very important factor in what they try and do. Faith said that her organisation does not see there being a compromise or a trade-off between the two but she thinks they can see that from the climate emergency being declared by over half of the local authorities within the country, that this is very much coming to the fore, particularly in climate change. She added that we’re seeing that it’s being picked up much broadly in the population but that we are also seeing concerns outside of climate change and cited the rise in single use plastics and the micro plastics issue. Faith added that we’re seeing a lot more people aware of these issues more broadly within the population and putting pressure on their investments more wholly, which she is very encouraging of them to do that.
Faith explained that the Sustainable Development Goals are 17 goals that were created by the United Nations and most countries have signed up to these. They represent things like abolishing poverty, climate change, building sustainable cities, life under water – a whole range of issues – and they are designed primarily for public policymakers. However, she said that we’ve identified that we need billions of pounds reallocated if we’re going to live more sustainably going forward and they are, therefore, from that perspective, quite a useful framework to identify macro socio economic risks from an investment perspective. From investment themes, Faith thinks that six or seven of them have more of a direct investment resonance, which can help from an investment opportunity perspective but for companies then going down to their level, she thinks that identifying which sustainable development goals they feel as a business that they can most positively contribute to is actually quite a good message for them from their own business and understanding their purpose and sees them connecting with the real world.
Faith said that one of the big challenges for investors is how to actually communicate on this issue. She added that what the SDGs were designed to do was to try and come up with a common language so that if they were talking to the person in the street about life under land or climate change or eliminating poverty, that was the same language then used by and linked to their investments. So, by creating that common language set, we have still got challenges about authentically reporting against those and making sure that we don’t have, what’s known as rainbow washing – these colourful goals that you can then mislead people that perhaps their money is being invested in ways to do good, whereas in fact maybe that’s a bit misleading. She said that there is a challenge around trying to come up with meaningful ways of reporting that and that this is an area that asset managers traditionally have not been great at doing, i.e. communication –Faith said she needs that information because she then also wants to convey those stories to her own beneficiaries. She added that they find increasingly that helps investors invest more, if they can positively connect real world issues with how they’re contributing through their pensions – it might be the only way in which they can actually allocate assets in a direct sense to solving problems across the globe.
Our next guest was Fadi Zaher, Head of Index Research and Development at Legal and General Investment Management, who had just finished running a session on bringing ESG into a passive investment strategy.
Fadi explained that his session was very much about integrating ESG into Index investment. He had talked through why it is important from an index point of view to integrate ESG, which he said was because you can get the scale and you can influence a broader number of companies compared to just a simple concentrated investment strategy. He said his presentation then looked at how to integrate ESG with different approaches, such as, optimisation, exclusions, which he added was the old way of doing ESG investing, but then he looked at another approach – that of tilting. He then showed a combination of different approaches and finished with some advice, the main advice being to keep it simple and effective.
Fadi doesn’t think that investors feel that they are disadvantaged by focusing on ESG because it depends on what their objectives are. So, if you have philanthropic objectives, you’re not expecting the money to come back in the sense that you’re just giving them for charitable donations. But he said that there are different areas within ESG where you want to have an impact. So, you could be doing some green bonds or social type of bond investing or it could be project finance where the ESG objectives are far more important than the return and the risk and return objectives, although there are areas where the risk and return objectives can still be priorities. He added that you can also look at the type of integrations, so you could do a tilting approach where you allocate more capital to companies that are good from an ESG point of view or you allocate less to companies that are poor from an ESG point of view, and build a solution that gets you similar to the market returns without having to actually give up too much of your investment objectives.
Fadi grew up and was educated in Sweden and so when reflecting on how the attitude to ESG investing is in Scandinavia compared to the UK or across the world, he said that he almost grew up with ESG in a way that society was built in the 90s and late in the 80s, in Sweden. He thinks that Northern Europeans are quite advanced when it comes to ESG today and that they have adopted all these approaches. They started with exclusions, they do their engagement with companies and try to change companies’ behaviours. He said that he was speaking at an ESG conference in Stockholm earlier this year, and that it was fascinating how advanced they are when it comes to how they integrated ESG into investment portfolios, but not only into investments portfolios, but actually in the general society. People are aware of it, probably more aware of it than in other countries that he had visited lately in Asia or even in North America. He added that the the government cater for that too, so if you want recycling, they have created an opportunity for you to recycle, if you want to have an investment that they see is ESG friendly, then the major pension funds are adopting that as default options. So ESG is very integrated into and deeply ingrained in the Swedish and Scandinavian societies in general. But Faid added that you need to have the political support and the consumers to be willing to participate to be able to do all that.
In summary, when it comes to ESG investing, Fadi said it’s very important to define your objectives. The objectives can be that actually you want an impact but if you lose out a bit from a return point of view or take a slightly higher risk, that’s fine. But you need to be very clear on these objectives. Alternatively, if your objective is to actually get the market returns, the market performance with an impact, be also clear on that. So, well-defined objectives are extremely important when you do this. The other thing he added was not to rely on historical performance. Common sense tells you it is the case. If you invest in well-governed companies, you are eventually, hopefully, going to protect your capital, but it’s very hard to empirically evidence that, simply because of the short history that we have [with the data]. So, don’t rely on backtesting and keep it simple – don’t try to over engineer a solution to invest in ESG, look into the future and engage with companies to change behaviour and drive the positive change.
Our final guest of this episode was Will Goodhart, Chief executive of CFA UK.
Will said the fact that the event had sold out and that they had close to 600 attendees, which was the capacity for the venue, was testament to the level of interest that CFAUK sees in the topic around ESG and sustainability and the demand that people have to understand it better and to be able to start building it into their daily working lives. He added that CFA UK had recently launched a new certificate in ESG investing and that, as the professional body for the investment sector, it is their responsibility to make sure that people are technically and ethically competent to do the jobs that people are paying them to do and that increasingly, what clients expect and actually what is being proven to be good practice is to be able to integrate environmental, social and governance factors into the investment decision making process. So, it’s absolutely incumbent on the CFAUK, as the professional body, to make sure that people are able to do that. Therefore, the ESG Investing Conference had been designed to allow people directly to benefit from learning from each other and learning from speakers, but also to provide CFA UK with content to take into version 2 of the official training materials for the new certificate, so that they can make sure that they’re really completely up to date and have covered all of the different topics that people are discussing in the market at the moment. Will added that the new ESG certificate is going very well and that people are enjoying the quality of the content and finding it extremely useful and feeling that they have benefited from going through that learning program.
According to Will, the whole world of ESG investing and responsible investing and sustainable investing is developing very rapidly and there’s a great dispersion in the amount of knowledge and experience that people have. What the CFA UK are therefore trying to do is to shortcut for people a way for them to obtain a necessary level of knowledge and skills as quickly as they can, that’s going to allow them to represent their clients properly or to meet their clients demands properly. He added that they can’t build into that years of experience that people will have gained from working specifically in this sector. But what they can do is point people at the right research, at the right data set, at the right techniques that other professionals that are already in the market can advise them that they should be looking at.
Will said that ESG investing has really evolved from a topic where people might have thought that it was something that somebody that was investing in accordance with somebody else’s values or beliefs, but that it would probably cost you money, to responsible investing where we accept that if you’re not taking ESG factors into account in terms of your own investments, you’re probably not doing your job well enough because you’re not understanding the kinds of risks that your portfolio has in, now to moving into sustainable investment where you’re thinking about what’s the impact on my portfolio on the world actually. So responsible investment, he thinks, is now pretty much mainstream, not entirely, but we’re certainly getting there, and what he thinks we will see over the next five years is a much broader acceptance and understanding of needing to invest sustainably because policy and regulation is going to drive us in that direction as we respond to the immediate climate challenge and some of the other sustainable development goals. He thinks that everybody feels a level of personal responsibility around this issue just as normal people. He said that we’re all conscious that climate change is happening and we’re all aware that as voters, we may express preferences for one political party over another. But he supposes that what’s different about investment managers is that clients are now starting to demand responses and changes to the way that their portfolios are managed and that CFA UK has the opportunity and the time as a professional body, to take the time to be able to address this properly. He said that actually it makes sense for them to be able to convene the right people to think this through, to then come up with the right guidance to help people act both technically and ethically, appropriately in undertaking analysis and managing portfolios, constructing portfolios and working with clients. He added that CFA UK is also now working with CFA Institute on the development of a new standard around ESG disclosures.
For more information from CFA UK, visit www.cfauk.org
The remaining show notes will follow soon