Show 89 – ESG Investing – The Practical Realities – Part 1

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The first of 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 1, Rachel Gatley we caught up with:
1/ Ben Yeoh, Portfolio Manager of Global Equities, Royal Bank of Canada Global Asset Management
2/ Sudip Hazra, Head of Sustainability Research & Responsible Investment, Kepler Cheuvreux
3/ Nina Reid, Director, Responsible Property Investment, M&G Real Estate
4/ Mark Lewis, Global Head of Sustainability Research, BNP Paribas Asset Management
For more information from CFA UK, visit www.cfauk.org

Ben Yeoh

Ben Yeoh

Chatting with Ben Yeoh

Our first guest was Ben Yeoh, Portfolio Manager of Global Equities at Royal Bank of Canada Global Asset Management

Ben started by explained that there are several reasons why today’s investors are looking at ESG:

  • Stronger demand from the client base, i.e. the consumer, institutional asset owners and pension funds.
  • Pressure from regulators globally as to being more interested in this whole area.
  • Investors who are interested because they believe that by using ESG techniques and ideas, we will be lowering investment risk.
  • Investors who think that you can use ESG techniques to also get better return on the opportunity side.
  • Giving you a set of tools and techniques to make better investment analysis and process to enhance your process, to have a better outcome even if you don’t think there is a direct link.
  • Set of tools and techniques which also help you to do engagement and stewardship with the investee companies or due diligence in and more enhanced manner across asset classes, whether that be in private markets but also within fixed income equities and alternatives.

Ben said that ESG, in general, is a little bit of a nebulous concept but if you look at various aspects of what makes up ESG, a lot of it can be classified as intangible value and there’s a lot of evidence today that some of those intangible values are not sitting on a company’s balance sheet. This can include corporate culture, innovation its human resources, human capital, intellectual capital, manufacturing and social capital etc. He added that if you’re very good in those other sources of capital, they are kind of the direct link into better business performance in sales and margins, which should lead to better share price appreciation.

Ben was presenting different ESG techniques at the event and spoke about is the use of a materiality assessment, which goes across a lot of asset classes and is the idea that we are trying to look at the causal material business factors which drive companies sectors or themes and trying to ignore the things which are less material because we think the material things drives companies and businesses and the less material don’t.

Sudip Hazra

Our second guest was Sudip Hazra, Head of Sustainability Research and Responsible Investment at Kepler Cheuvreux.

Sudip Hazra

Chatting with Sudip Hazra

Sudip believes strongly that ESG is no longer optional but an essential prerequisite of any organisation. He thinks that there’s lots of different drivers right now and in terms of where we are, one of the big things that’s really pushing asset managers is regulation. He said that particularly in the EU, there is a lot of political agreement, which in the longer term, is bringing asset managers to a place where they have to think much more deeply about ESG, and he thinks for the most part, there is a lot of agreement that ESG can add value, but that it is about understanding how and in what specific ways it does add value.  He said that the way that regulation is going, for example, on the environmental side, we’re likely to see a lot more interest, both from the investor side and corporates in disclosing much more technical detail, which will allow us all to really look at how environmental opportunities can be quantified in the investment world.

Sudip said that in general, the consumer space has been very interesting because that’s one of the areas where he thinks we can see instant feedback. He said that if you’re buying something and particularly if you’re paying slightly extra, for example for a health benefit, then usually you’ll be very reactive if you don’t like some of the sustainability aspects of the product that you’re paying more for essentially. So, Sudip thinks in the consumer space, particularly premium consumer goods, they’ve been very reactive and we’ve seen a lot of movement where clearly there have been some good opportunities and some of the big brands are really beginning to take advantage of that, and we can see revenue generation there.

Sudip also believes that until now, risk avoidance has been a major driver towards adopting an ESG approach to investment.  He added that if anything, ESG risks are growing. But in fact, it’s probably more on the opportunities side where we see more new interest, where we see mainstream investors really stepping in because, to some extent, they understand within the ESG that governance has always been a big risk but they’re really seeing more opportunities across ESG which they can start to really take advantage of.

Sudip also agreed that balance has shifted and meeting ESG standards has now become perhaps more of a mainstream expectation for investments.  He thinks that the only way that that can go is forward. So, right now Sudip believes that we’re still in a space where ESG could be considered more material but for the most part many investors have quite regularly seen examples of material impacts from ESG issues. And in terms of the way that that’s being implemented, he would say that ESG is no longer considered optional. He added that across the board, particularly in Europe, the vast majority of asset managers are just beginning to take it on board if they haven’t before.

Nina Reid

Nina Reid is Director of Responsible Property Investment at M&G Real Estate and her talk at the event was in one of the asset class focus sessions looking at property.

She explained that M&G Real Estate has around £33bn worth of assets under management globally and her role is to integrate responsible investment considerations so environmental efficiency, health and well-being, and socioeconomic impact into investment decision making and their asset management decision making and day to day operations of the buildings.

Nina Reid

Chatting with Nina Reid

In her session at the conference, Nina had given an overview of how M&G Real Estate had gone about integrating responsible property investment into their investment strategy for their funds under management globally and then had a deep dive into two topics:

  1. Climate Risk
  2. Health and wellbeing and occupier experience in their buildings

Nina said that Health and Wellbeing is an interesting trend that’s in the real estate sector that has grown over the past three to four years.  She thinks this is due to the growing recognition of the impact that buildings can have on the health and wellbeing of people who live and work in them.   She said that we spend around 90% of our lives indoors, and therefore, the built environment has a huge impact on our wellbeing.  She added that with the rise of devices and the ability for people to understand air quality and how that might impact them has created a growing engagement with the built environment as to how we might improve that experience for people. She also thinks that from a business perspective and their occupiers, there’s also growing evidence about how this all might impact the productivity of the workforce and how it may play a role in whether people want to come and work for a company because of the facilities that it provides, particularly within the office environment. She also talked about how, within the developed markets, there is an ageing population – people with different needs – and so her company needs to think about how their buildings are able to accommodate people with a very different range of physical and mental needs.

Nina thinks that on the health and wellbeing side, the increased focus in this space has been occupier driven and then driven through the employees who work for corporates in particular. However, on the environmental side, she thinks it’s probably more legislative although she added that the public awareness that we’ve seen through the recent global climate strikes is obviously also having a bottom up effect on individuals asking their employers or where they work, what are they doing about climate change.

Data still remains a challenge though.  Nina thinks there are some markets in which data quality has improved quite dramatically and she said that obviously as a real estate owner, there are assets where they can get data directly because they are in charge of the utilities, but there are also assets where the tenants are in charge of, and getting the data from the tenants is always more challenging. She does think that that is changing though, as occupiers are more aware of why they are being asking for the information and also as the legislative frameworks improve. She also thinks that there is a role for perhaps the building certification providers to enable that data to be more usable and more accessible and in turn, occupiers being able to demand these kinds of simple standards that is understandable by the market.

Nina thinks that there’s a degree to which, as with reflecting on the other asset classes that you hear, that having that data and information about a broader set of factors than just financial performance is always valuable in terms of understanding what leads to buildings being successful and how can you support your occupiers in meeting their business requirements. So, being able to have data and information about environmental performance and how the indoor environment can benefit their occupiers is always very valuable. She added that there is both the premium element and also the risk and stranded assets that understanding performance helps you identify risks and understand how you might mitigate against those.

With regards to sustainability and the environment and the space that they work within, Nina said that M&G Real Estate and a number of other large property owners have recently committed to net zero by 2050 across their global portfolio.

Mark Lewis

Our final guest on this episode was Mark Lewis, Global Head of Sustainability Research for BNP Paribas Asset Management and also a member of the FSB Task Force on Climate Related Financial Disclosures (TCFD). Mark’s session at the event was entitled ‘Policy in progress’.

Mark Lewis

Chatting with Mark Lewis

Mark said that he’s been covering energy and climate change and the overlap between the two for the last 15 years and when he talks about a ‘feedback loop’, what he means is the interaction between policy on the one hand and technology on the other. He said that governments, fifteen years ago in Europe, started putting in place subsidies, or incentives, for renewable energy and when you have a subsidy, it attracts capital. When capital flows into a new sector or a new technology, you start to see the expansion of the activity and you start to get economies of scale, and that leads to the cost coming down, which means that it becomes easier for governments to set tougher targets and the cycle starts to repeat itself. Mark said that this is exactly what has happened in the European power sector over the last 15 years where the cost of renewables has come down.

He used the examples of solar, where the cost of has come down by 85% in the last 15 years and of wind, which has come down by 70-80%. Mark said that these technologies would never have been in the position they’re in today if governments hadn’t put those incentives in place at the beginning. He stressed though that, although the subsidies might seem expensive at the beginning, by the time you factor in the time you save because of the capital you attract earlier than would have otherwise been the case, it more than pays back for itself. However, the flipside to that is that is the incumbent technologies that are threatened by the new entrant, in this case, renewables, which suffer because as the cost of renewables has come down over the last 15 years it’s had this tremendously disruptive impact on the European utility industry.

Mark said that utilities are traditionally regarded as the safest industrial sector you can invest in – when you invest in a utility, traditionally you’re meant to be investing for capital protection above all else and you also expect a dividend. You don’t necessarily expect big capital appreciation, but you expect capital protection. He added that over the last 10 years, the European utility sector has lost close to 50% of its market value, market capitalisation. In the case of the German utilities they’ve lost between 70 and 80 percent of their market capitalisation. Therefore, what we’re really talking about here is a tremendously disruptive force in the form of renewable energy. Mark believes we’re now at the point where renewable energy is going to start threatening other incumbent energy industries, not least the oil and gas sector and he said the reason is that the feedback loop now has two further very important multipliers.  So, in addition to public policy and technology, Mark said you have the investor response to that feedback loop – investors have had 10-15 years to observe what’s happened in the European power sector and want to avoid losing money again on another major industrial sector. And at the same time, he said we’ve seen growing societal pressure in the last 18 months to two years, particularly in the last 12 months around the issue of climate change.  He said that the ‘Greta Thunberg effect’, the schoolchildren strike for climate change, extinction rebellion – there is a huge upswell – groundswell really – of public opinion on the need to take bold climate action and that is only going to further exaggerate and exacerbate the impact of the feedback loop because if governments start setting even more ambitious targets for the future, that feedback loop is only going to intensify and accelerate going forward.

Mark agreed that some of those external factors, combined with the policy and legislative approach, have sped the process, which is impacting on the pace of adoption of ESG measures and that it is a very important extra driver. He added that this can be seen as a leveraging of the existing feedback loop between policy and technology.

Mark explained it by saying that the inner loop would be policy and technology and then you have investors acting on companies to improve the speed of adoption of new technology and society more broadly having an impact on government policy to put in place more ambitious targets.

FSB Task Force on Climate Related Financial Disclosures (TCFD)

Mark said that TCFD is an initiative founded by Mark Carney in his capacity, not as Governor of the Bank of England, but when he was Chairman of the Financial Stability Board, which Mark described as the closest thing to a global financial watchdog. He said that it’s a body that looks at the financial system for the G20, the leading 20 economies in the world, and drawing on the experience of the global financial systems reaction to the financial crisis in 2008/2009, where subsequently, they put in place a task force to look at what were the major lessons that could be learned in terms of adapting the financial system, making it more resilient to external shocks in the future.  He added that Mark Carney thought that climate change is one of the megatrends, perhaps the defining megatrend of our age, and that climate change brings with it very significant implications for the financial system and for the stability of the financial system and therefore that it was appropriate to put in place a task force that would think through, very methodically:

  • what are the drivers of change in the financial system from climate change?
  • where are the risks?
  • what way does climate change manifest itself as a financial risk, as a systemic financial risk?

Mark said there are 30 members of the TCFD and their first report was published in July 2017 and that they are now in the implementation phase of that process.  He has been pleasantly surprised at the momentum that the TCFD initiative is now gaining the traction amongst both companies and governments but said that it is important to remember that this was seen as a voluntary initiative – it was a way for in Mark Carney’s own words, for industry practitioners, people from all walks of financial and industrial life, to come up with decision critical recommendations around the reporting and disclosure of climate change risks with a finite financial dimension. Mark said that the idea is that if the people best placed to make these recommendations put them down on paper, the market can then have a more informed conversation over time and in Mark Carney’s words, you end up developing a market in the transition towards a two degree world. Mark said that this is what it is really all about, and that that’s exactly what is now transpiring both from investors and companies, plus governments are now responding to the recommendations – companies in the form of giving more disclosure, investors in the sense that they are requiring more disclosure from the companies they cover and governments saying ‘well actually, the systemic financial risk here could be extremely important, perhaps we ought to think about making the voluntary recommendations that the TCFD put forward mandatory’.

Mark said that the UK Government, the first in the world, has said that from 2022 it will be mandatory for UK companies to report climate change risk under the aegis of the TCFD recommendation. So, he thinks it’s the right moment to accelerate the debate in the market around this – give the market more information and let the market try and figure out what the most important information it needs is. He added that companies that respond to this in the best way, that really look more rigorously than other companies at where they are exposed in terms of their climate change risks and report on that to their shareholders and other stakeholders will, by necessity, probably make more informed choices about their future strategy than companies that do not take this process as seriously.  Therefore, over time, the market will be able to discriminate more clearly between companies that are responding appropriately to the threat of climate change and those that are not and as a result, you will end up ultimately with a more efficient allocation of capital within the global financial system i.e. an allocation of capital that takes into account the risk of systemic financial risk from climate change.

Having covered this area for 15 years, Mark said that there been plenty of times where he has felt pessimistic but he’s said that he is now in the curious position where, on the topic of climate change, he gets more optimistic the longer he is in it.  He added that the main reason for that is that the economics of renewables now have gone mainstream – we know that renewables can more than compete with traditional sources of energy provision – in terms of power generation, renewables now are very clearly the cheapest source of new electricity generation throughout the world. Mark said that solar, in particular, has further to go in terms of reducing its costs but if you go back 15 years, no one would have believed we would be where we are today in terms of the cost reductions that we’ve seen. So, he thinks that’s an unmitigated, unqualified success story. The big challenge over the next decade though is to develop storage energy, storage technologies that can build on the success of renewables and store the solar power and the wind power that is generated when it’s not needed and bring it back to people when they do want to consume it.

Mark thinks that climate change is driven largely by anthropogenic greenhouse gas emissions, of which the energy industry accounts for 70%. He said we know we can decarbonise the energy industry … the question is, can we match people’s need for energy with the availability of energy, and only storage will really enable us to put that final piece of the jigsaw in place. Mark therefore believes that if we can solve the energy storage problem, we can ultimately solve the climate change problem.



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