Read this article to understand:
- The differences between ESG integration, ethical investing and sustainability
- Exactly how ESG integration allows asset managers to spot and manage investment risks and capture opportunities
- Why clear labelling of terminology and products has a key part to play
‘Inconsistent.’ ‘Inflexible’. ‘Saintly’. ‘Woke’. ‘A movement blighted by hype and woolliness
In recent months it has been hard to ignore the growing cynicism towards ESG. Yet while criticism of the disproportionate claims made by some asset managers about their responsible investment credentials is warranted, condemning ESG in broader terms as a worthless vanity exercise shows a lack of understanding of what it is and there to achieve.
Too often, ESG has been used as a generic catch-all position, lumped together with ethical investing, stewardship or sustainability: they are, of course, linked but are not the same thing and shouldn’t be portrayed as such.
Some commentators have cited Russia’s invasion of Ukraine as ‘evidence’ investors have mistakenly turned away from fossil fuels on ESG grounds
In the latest example of ‘wise after the event’ disapproval, some commentators have cited Russia’s invasion of Ukraine as ‘evidence’ investors have mistakenly turned away from fossil fuels on ESG grounds and are ‘too focused on climate change’.
There are a couple of points to make here. First, we were among a number of asset managers that had limited exposure to Russia going into the crisis (in our case less than 0.1 per cent of AUM). Our negative view was largely driven by ESG considerations, which are a core input in our investment process.
Second, Russia’s invasion only highlights the urgent need to accelerate the energy transition, so we are not dependent on supplies from hostile and unpredictable regimes. We must form a principles-based view of what kind of world we want to live in and take strategic actions to build it. In doing so, we recognise fundamental system-wide change is hard, requires sacrifice, and we have to accept the short-term criticism that comes with it.
Defaulting to pragmatic positions based on how the winds are blowing today means, by definition, tying ourselves to the status quo. Reverting back to coal, for example, in the face of the biggest systemic threat to the planet (and therefore companies and countries) does not constitute grown-up strategic thinking.
That anyone can dismiss ESG as a vanity exercise is as mystifying as it is disconcerting. Investing responsibly is not a fad; it is an investment belief. Companies, and indeed governments, that conduct their business in a respectful and sustainable way are more likely to succeed in the long term. Bad practices don’t just hit the headlines, they hit the bottom line as well. It is that simple.
As such, integrating ESG into our investment process is non-negotiable. Understanding these issues allows us to spot and manage investment risks, as well as capture opportunities.
We should also not lose sight of the fact regulation is rightly pushing capital towards more sustainable investments, or the many reasons why clients large and small want and need to invest more sustainably – not least to avoid the potential losses from holding stranded assets that will not be part of more sustainable economies.
They must be clearer about what ESG is and what it isn’t
Where we do need to do a better job is in being crystal clear in our communications when we talk about ESG, especially in explaining the nuances. Asset managers’ approaches to ESG are relative, subjective and non-binary – they are not objective and singular.
Being responsible stewards of our clients’ assets is how we can differentiate – especially when we move into ESG activism. Through our active ESG engagement programme, we believe we can be a force for positive change in the companies we invest in, economies and societies. We’ve been using our influence and voice – sometimes very loudly – in this way for five decades.
ESG integration is purely investment orientated: it assesses the risks and opportunities associated with various ESG factors and embeds them in the investment process alongside financial analysis. It is pragmatic and appropriate for all clients and strategies, providing essential information to portfolio managers to inform their decisions and drive better financial outcomes.
ESG integration does not, as some misinformed commentators have it, mean blanket exclusions from certain sectors, particularly those subject to external scrutiny. On the contrary, ESG analysis is often the critical input in deciding whether we have an opportunity to turn ‘brown’ assets ‘green’.
When we are successful in doing this, we believe it can add value to most investments, irrespective of asset class, whether that is pushing energy companies to move more quickly and decisively in transitioning to renewables; refurbishing older buildings to increase their relevance for a low-carbon future; engaging with agricultural companies to stop their use of antibiotics in the food chain; or seeking to improve human rights in the supply chains of fashion companies. Such actions aren’t ‘woolly’ or taken because they make us feel better – they are commercially driven and allow us to meet our fiduciary duty.
ESG integration does not, as some misinformed commentators have it, mean blanket exclusions from certain sectors
There are times when we exclude investments at a business, fund or stock level and these decisions are driven by values and ethics. Exclusions will vary between asset managers, and their funds, and will be issue-specific and nuanced. An ethical fund is so called because of its ethical policy. To repeat: it is not the same thing as ESG integration.
Similarly, “sustainable” is an ambiguous phrase and routinely misused. It is a system condition, not a state of being for an individual, fund or institution in isolation. Sustainability is an ambition and sustainable finance will have a huge role to play in helping us get there.
It should be acknowledged that achieving sustainable outcomes and correcting market failures are exceptionally difficult, hard to measure and require a system-wide view alongside consistent, long-term engagement with governments, regulators, multilateral organisations and other policymakers. This type of macro stewardship is another way asset managers can differentiate.
Clients that want to go above and beyond ESG integration can today select solutions deemed ‘ethical’ or tied into helping deliver ‘sustainable outcomes’ such as net zero emissions. Back to my point on the need for clarity, there is currently no simple and easily understandable scale from light green to dark green in terms of fund offerings.
This has created confusion, something that has not been alleviated so far by SFDR fund classifications in Europe. Customers need clear labelling, and the UK can improve on this with its own classifications, something the industry is collaborating on to encourage. A huge amount of education will then be required to ensure customers truly understand the products they are investing in.
It is up to asset managers to define exactly and clearly their values, priorities and red lines, and how these are embedded within their offerings
It is up to asset managers to define exactly and clearly their values, priorities and red lines, and how these are embedded within their offerings. Clients can then choose managers whose philosophy, approach and products most closely align with their own views.
There will always be dissenting voices, but by making a concerted effort to better explain the terminology and creating clear product choices, we can put the ESG backlash back in its box.