Responsible investing may have become a familiar buzzword, but how much of it is actually going on? Widely conflicting views on this are bandied about, from those who believe it is still a niche area to others who argue many large investment groups are now on board.
The truth is a patchwork, and a puzzle. Systematic attempts to measure the market all show that it is very large, and growing fast.
Eurosif, the European Sustainable Investment Forum, does a biennial survey of European investors. It found that in 2011, €6.76tr of assets were being managed under six kinds of responsible investing strategy — about 35% more than in 2009.
François Passant, executive director of Eurosif in Brussels, points out that SRI is growing faster than the asset management industry as a whole. “Based on European Fund and Asset Management Association annual statistics, between 2009 and 2011 the overall market for professionally managed assets grew by about 7.8% to about €12tr,” he says. “All the SRI strategies have grown faster than that.”
The UN Principles for Responsible Investment — the widest known global initiative to promote this movement — is also gathering adherents fast. At the last count in April 2013, $34tr of assets were managed under the PRI, which has 1,200 signatories, of which about 770 are investment managers. The PRI organisation reckons this is about 15% of global capital.
| AP2 seeks value in sustainability |
| The Swedish national pension fund known as the Second AP Fund, or AP2, manages €26bn of assets under a commitment to sustainability, which embraces environmental, ethical and governance issues. The fund has no specific SRI portfolios, and its index-linked investment is purely quant-driven. But portfolio managers using fundamental analysis screen their investments twice a year to spot any companies that have broken international conventions or guidelines. AP2’s ethical council examines any red flags. “The Fund’s basic response,” says Ulrika Danielson, an AP2 spokesperson, “is to exploit its influence as a major investor to ensure the cessation of any breach and to see that measures are taken to preclude any future infringements. Only where none of this can be achieved does the Fund consider disposing of its holding in the company.” These efforts towards sustainability are designed to create value, through more solid analysis, but also to promote good business ethics and an environmentally responsible attitude. |
||
“The total assets under management that are SRI-directed will keep growing,” says Michael Eckhart, head of environmental finance at Citigroup in New York. “It will never be 100% of all money managed, but without doubt it’s getting bigger and it will accelerate as the next generation gets into management positions.”
Favourable demographic
Practitioners, especially in the US, say younger people and women are more likely to want environmental, social and governance (ESG) issues taken into account when they invest.
There is great variation around the world. The Nordic region and France are often cited as the places where responsible investing has the greatest hold on the asset management industry, reflecting, in different ways, the cultural values of those societies.
UK pension funds and asset managers are strong in international forums and initiatives, partly because of the size of the country’s fund management industry, and London has attracted specialised sustainable investing boutiques like Generation Investment Management, founded by former US vice-president Al Gore and investment banker David Blood.
There is significant interest in Germany, the Netherlands and Australia, especially among pension funds. Canada is a little further behind, specialists say, and the US some way behind that — though it has recently become the top country by number of PRI signatories. Some deep pockets of demand have been found in the US for recent ‘green bond’ issues among cash-rich corporate treasuries and the private wealth sector, though much of this does not follow a systematic responsible investing plan.
In Asia and the developing world, Japan — especially its Uridashi retail bond market — South Korea, Brazil and South Africa all show degrees of involvement, while latterly some of the Chinese sovereign wealth entities have taken interest on the environmental side, one banker says — aware that the country faces heavy strains, particularly water shortage.
Audible silence
However, sceptics tell a different story. “One leading company told me they couldn’t think of a single time that a mainstream investor had asked a question about their environmental performance,” says Justin Keeble, head of Accenture’s sustainability services practice in Europe, Africa and Latin America.
The doubters argue that assets can get classified as managed according to SRI criteria even if these are fairly limited and generic — such as excluding ‘sin stocks’ like tobacco, alcohol, pornography or weapons.
Equally, an organisation can sign up to the PRI without really doing very much in practice.
A different approach to measuring sustainable investment is taken by Ethical Markets Media, a US organisation that since 2007 has published a Green Transition Scoreboard.
This is an effort to count all the private sector investment that furthers the transition to a sustainable economy, irrespective of motivation. This includes investments made by companies, not just portfolio investment by funds. The authors of the survey take a fairly strict line on what is green, excluding nuclear power, biofuels and shale gas, as well as anything that relies on government subsidy. Yet they have some encouraging news.
| Amundi: taking ESG to the whole organisation | ||
Amundi — at €750bn of assets, Europe’s largest fund manager — is widely seen as a leader in SRI. It launched its first fund with Catholic-inspired exclusions in 1989 and began best-in-class investing with a governance-driven equity fund in 1998. By 2003 it was still a niche with €400m of assets, but since signing the PRI in 2006, Amundi has started to integrate ESG criteria across its entire range of activities. The firm’s approach is quite simple. “We rate 4,600 companies on a scale of A to G, according to ESG criteria,” says Antoine Sorange, head of extrafinancial analysis at Amundi in Paris. “Except for specific client mandates, we don’t exclude any industry except cluster bombs, which are illegal to invest in in France. Non-SRI portfolios cannot invest in the equity or bonds of any company rated G, and SRI portfolios exclude those rated E, F and G.” The scale is a normal distribution, so the G band includes about 3% of businesses in that industry, while E, F and G together account for about a third. To do this, Amundi has 10 extrafinancial analysts, who rely on eight external data providers: MSCI, Sustainalytics, Vigeo, Oekom, GMI, Ethix, Reprisk and Factiva. When the signals from two of these data providers disagree, Amundi’s system generates an alert; the analysts then examine the issue themselves and reach a decision. Amundi also monitors the news for controversies involving companies, and then investigates them. “It’s very important for us also to meet companies, both to refine our ESG ratings and also to engage with the company,” says Sorange. “We ask them to improve their sustainable development policies, and also meet NGOs and trade unions so we can make up our minds when there are controversial issues.” For the past two years, the firm’s extrafinancial and SRI experts have joined mainstream analysts and fund managers when Amundi goes to visit CEOs and CFOs. To ask more detailed questions, the ESG team also have dedicated meetings with heads of human resources or sustainable development. Sorange explains that Amundi’s approach of including every industry means a coal miner or tobacco company could end up with an acceptable ESG score. “If you want the tobacco industry to improve its practices, this is the approach,” he says. “Tobacco is real — let’s make that company have the best policies regarding responsible marketing and not having children working in its plants.” Using engagement in combination with ratings also makes sense, he says. “In Canada and Australia, asset managers are more into setting up resolutions at AGMs, but not rating companies,” he says. “But if you don’t rate them how can you measure their improvement? ESG ratings also give the fund manager information about the risks the companies face.” |
||
“People have a hard time believing the global green economy is as large as $5.2tr,” says Timothy Nash, president of Strategic Sustainable Investments, an educational group in Toronto, and one of the Scoreboard’s authors. “Mainstream economists are too quick to dismiss anything labelled green, and there have been so many opponents of the transition, especially from the embedded interests in the oil and gas industry.”
Like many other committed greens, Nash is keen to emphasise the positive: that a more sustainable economy can create jobs, and is beginning to happen.
Pension funds put the squeeze on
Another sign that the tide may be turning in favour of responsible investing (RI) comes from the market where pension funds, known as asset owners, award mandates to investment managers.
“There is a strong focus on integrating RI issues into the investment process across asset classes — from private equity to infrastructure and public equity to corporate credit,” says David Russell, co-head of RI at USS Investment Management, part of the Universities Superannuation Scheme in London.
“There is also a focus on pension funds better monitoring how their managers are integrating RI into their processes.”
Sarbjit Nahal, global head of thematic investing strategy at Bank of America Merrill Lynch Global Research, says at least seven out of 10 requests for proposals for equity management mandates now specify that asset managers can address ESG issues. “There is increasingly a push on fixed income too,” he says. “This means asset managers have got to take these issues on board, or they will be at a disadvantage competing for business.”
Broad church
If so many trillions of assets are being managed responsibly, how come there is still so much confusion about quantifying this? And why isn’t the moral army making itself felt more powerfully?
The main reason is that responsible investing is not one body of thought and practice, but a broad church. Ethical, ESG, socially responsible, sustainable and responsible, just responsible or just sustainable – participants in the field like to correct you if you use a term they don’t like.
The debates over terminology seem to arise because one name or other becomes associated for a time with a particular way of doing responsible investing.
When a new approach becomes fashionable, no one wants to be associated with the old one, especially if it sounds too niche or morally-driven.
For example, SRI is sometimes used pejoratively to denote an old-fashioned focus on excluding bad investments for ethical reasons, as contrasted with analysing ESG factors as material to the financial performance of every company.
In reality, these two approaches are compatible and often practised together.
“We try to avoid the whole
buzzword debate,” says Nahal at BofAML. “You’ve got to frame it how the clients want it.”
Ways to skin a cat
More objective study of the industry, such as that by Eurosif, dissects it into half a dozen strategies. Exclusion and norms-based screening mean refusing to invest in organisations deemed harmful, either because their whole industry or region is condemned, or because the individual issuer fails to meet publicly agreed standards, such as the conventions of the International Labour Organisation.
Best-in-class — the commonest approach in France — involves ranking or rating issuers in a given sector according to their ESG policies or performance, and then excluding the worst performers, or only investing in the better half.
Inclusion and sustainability themed investing is about seeking out companies the investor believes are either helping to improve the world, or stand to profit more than others from long term trends like climate change or an ageing population.
Finally, engagement, popular in the UK and Australia, involves using your clout as an investor to influence the companies you invest in.
These varied approaches are implemented in different ways by different fund managers, and often two or three strategies are used in combination.
Big and small get involved
As the investor profiles on these pages show, this wide range of analytical techniques is overlaid on fund managers of many different types. Some of Europe’s largest institutions are trying to integrate thinking about ESG across much or all of what they do. Expertise often spreads out from a single portfolio.
At the other end of the scale are smaller, specialist firms founded with the express mission o f sustainable investing.
Institutions also differ greatly in their degree of strictness about the criteria they track. Some, like Amundi, see no problem in buying into fossil fuel producers — the firm’s head of extrafinancial analysis, Antoine Sorange, even argues it is hypocritical to exclude oil companies and then travel by plane.
That approach would win scant praise from 350.org, the US student movement campaigning for universities and public sector investors to divest from the fossil fuel industry.
| Storebrand lands some punches for sustainability | ||
| Storebrand, the Norwegian life and pensions company, claims to have established the first environmental investment fund in Europe, in 1995, in partnership with Scudder, Stevens & Clark of the US. It grew into a mutual fund family including a bond fund. “What’s important,” says Christine Tørklep Meisingset, the firm’s head of sustainable investments in Lysaker, “is that it was the business case that was the driver of establishing this fund. We thought it could outperform. In the Nordic region the debate has been really hung up on ethical dimensions, which are often perceived to be negative and hurt returns. We have ethical standards too but it’s only a small part of what we do.” Storebrand began with a best-in-class approach and has now developed that analysis to be more forward-looking, and uses it in combination with negative screening and engagement. This combination, Meisingset says, “is sometimes where the magic happens”. Hunting out the worst performers to exclude helps you understand issues like corruption, war and human rights, while engagement with companies brings other insights. These inform Storebrand’s work in rating companies. Using some bought-in data, Storebrand gives each firm a score from 0 to 100 that combines both ESG factors and financial ones. The worst 10% of performers are excluded, as well as all controversial and nuclear weapons and tobacco companies. Then Storebrand watches for scandals. “Allegations on corruption, HR breaches, environmental degradation — it’s a case by case analysis,” says Meisingset. “We typically ask questions about how the scandals are managed. We are primarily concerned with the risk of recurrence.” When BP’s Macondo oil well exploded, for example, Storebrand met BP executives. “It’s complicated. It’s been a difficult case,” says Meisingset, but Storebrand concluded that “obviously something’s gone wrong but we’ve got sufficient information that we believe the risk of recurrence is very low.” The firm is taking a similar approach this year to GlaxoSmithKline’s bribery scandal in China. A harder line was evident in this summer’s decision to exclude from all Storebrand’s portfolios 13 coal companies and six involved in oil sands. “The aim of these exclusions is to reduce Storebrand’s exposure to fossil fuels and to secure long term, stable returns for our clients,” Meisingset declared at the time. “If global ambitions to limit global warming to less than 2°C become a reality, many fossil fuel resources will become unburnable and their financial value will be dramatically reduced.” |
||
Some fund managers, like Storebrand, have dumped some carbon-heavy companies, while firms like Generation and Pax seek out the likely winners from a new sustainable economy.
Nash at SSI, who assists retail investors wanting to invest sustainably, advises them to stay away from green tech companies as they face big risks, but look for companies earning stable revenues. “There are some wonderful renewable energy ETFs,” he says, “and water infrastructure ETF returns have been phenomenal. I would love to see a green Reit.”
Feeling the effects
But while the leaders undoubtedly take responsible investing to heart, are these isolated beacons? Are they surrounded by a sea of half-hearted souls who pay lip service to grand principles but carry on more or less as before?
“I think it’s quite a broad spectrum,” says Mike Ramsay, head of the credit team at Generation Investment Management in London. “Arguably, some of the PRI signatories have done it because they think they should, and their investors would expect it — it’s more of a marketing exercise. But many definitely walk the walk. Hopefully their staffers will begin to be judged against the PRI principles and not just against the performance metrics of their investments.”
Is SRI yet important enough to affect how a company’s shares trade? “We are getting there. Not sure we are quite there yet,” says Luca Torchia, head of investor relations at Enel, the Italian power group, in Rome.
“It is difficult to say if it has made a difference to our share price, almost impossible,” says Carine de Boissezon, senior vice-president of investors and markets at Electricité de France in Paris.
But she, and EDF, certainly behave as if it does. “EDF’s freefloat is very small, so our share price is really influenced by the marginal buyer,” de Boissezon says. “I want to get new investors, and get them to value all the things we are doing. We’ve entered the FTSE4Good index — so you give investors no excuse not to look at EDF.”
When de Boissezon joined EDF in 2010, one of the first things on her desk was a letter from a shareholder, stating that EDF had passed all its criteria for climate change adaptation and would continue to be eligible for its portfolios. As it was one of the biggest fund managers in the world, that was quite a relief.
Enel calculated in 2012 that 14.6% of its institutional investors were SRI-driven, up from 13.9% the year before.
| Generation: hunting for tomorrow’s winners | ||
| Mike Ramsay, who runs the credit team at Generation Investment Management in London, says the firm was formed in 2004 under two key premises. “The first was a view of the original partner group that public equity markets were too short termist in outlook. Mandates were often forcing asset managers to take short term trading decisions around price volatility, rather than allowing them to take a more medium or long term view on business models.” Generation’s second premise was that “Sustainability, broadly defined, had been manifested in the investment world either through a top-down filtering strategy, or through impact investing, where it was effectively a concession of financial return for some other type of return or soft benefits.” Instead, Generation wanted to integrate sustainability into a very traditional investment process. “Rather than badging or doing a box-checking exercise,” Ramsay says, “it’s looking for companies or sectors that over time would be stronger, and have a higher quality of earnings, so driving an increasing share price.” Generation analyses different industries, countries or themes like water, urbanisation or poverty, to work out what their medium to long term paths are going to be, and which ESG issues are material to that path. In the solar power field, for example, it might be companies making key components, or in healthcare, manufacturers of artificial hips whose sales practices are not going to land them in an ethical scandal. “We look for a company that is part of the solution or at least neutral with a transition to a lower carbon economy, so we can pick business models that we believe will just get stronger over time,” Ramsay says. “Importantly, we have aligned that process with long term capital from investors who understand that patience is a virtue.” Generation’s flagship product is its global equity fund, which invests in a concentrated portfolio of 30-60 listed companies that have dominant market positions, impressive managements and will benefit from secular growth trends linked to sustainability. It also has a climate solutions strategy, which invests in growth companies, including private ones, that will generate value from the shift to a low carbon economy. |
||
Torchia says these investors “keenly follow sustainability, human rights, health and safety and ethics issues and ask us questions regarding ESG issues regularly whenever we meet them.”
And what the investors want to know about is evolving. “Issues like the company’s carbon footprint, water usage or diversity were never brought up,” Torchia says. “There used to be little to no interest in the company’s very strong CSR [corporate social responsibility] initiatives. Now we are incorporating them into our roadshows.”
Pension funds, because of their long term liabilities, need to address ESG issues that could cause problems in the future, Torchia says. “Some major banks already have an ESG global research team,” he adds, “something relatively new in the classic institutional investor world — but they, too, are starting to realise that these indices help measure the future soundness of a company.”
De Boissezon says she has met investors who were clearly box-ticking, or who seemed cynical about SRI policies that had been imposed on them from above. “But there are some specialist utilities funds which may be quite small, but because they are thought leaders, they get time with management on the roadshow,” she says. “They challenge management.”
Old economy motors on
After all these efforts to promote responsible and sustainable investing, do its champions have any tangible achievements to show for it in the real world?
SRI has not stopped the capital markets leaping to finance every new kind of industrial activity, from biofuels — whose low-carbon claims are hotly disputed — to genetically modified organisms and drilling for oil in the Arctic.
Does it, for example, dismay Joe Keefe, CEO of sustainable investment firm Pax World Management, that the shale gas fracking industry has mushroomed in North America in the past five years, paid for by the institutional investment industry?
“Yes,” he says. “Markets are still very short term-focused. There are a lot of disincentives in the market to longer term planning and valuation, from quarterly earnings to the way capital gains are taxed. Shale gas is a great example.”
Other SRI practitioners defend these industries. Sorange says Amundi looked into fracking and decided there was nothing wrong with it, as long as it was done to high standards.
Nahal at BofA Merrill argues: “It’s not for us to make value judgments. Our role in research is to provide clients with ideas. With shale gas there are two sides to the coin.”
On one hand, gas as a transitional fuel is less carbon-intensive than coal. On the other, Nahal says, some fracking is being done in areas like Colorado and Texas that are water-stressed, and it takes millions of gallons of water to frack a well. He adds: “That water is also going to come back to the surface laced with the chemicals you used for fracking.”
For Merrill’s thematic investing experts, that might suggest, for example, seeking out companies making water treatment equipment.
Banks in the middle
One banker is baffled by the US government’s changes of direction on energy policy, so that now it gives grants for fossil fuels instead of solar panels. But he sees it as natural that banks should be involved in financing the full spectrum of energy companies.
“We are not a philosophy house, we’re a bank,” he says. “If clients want to raise capital, we will help them. We have people serving the aluminium industry — that’s not in conflict with our lending to the steel industry. It’s different from the investment industry where investors make policy decisions on use of funds. We don’t allocate funds philosophically. We have many corporate clients — we’re here to serve them.”
In some regions, thinks James Gifford, executive director of the Principles for Responsible Investment Initiative, responsible investing has made a difference to how companies behave — notably Scandinavia, Denmark and the Netherlands. “It’s part of the whole culture there,” he says, “but investors are right there at the forefront, sending similar signals to the consumer and the media.” In Australia, too, there has been a lot more shareholder dialogue.
Passant at Eurosif says many asset managers are starting to think about developing indicators to measure the impact of what they do.
Teaching some lessons
Successes are easier to spot at the micro level of individual companies. Christine Tørklep Meisingset, head of sustainable investments at Storebrand, recalls the Siemens corruption scandal. “We saw a pattern of allegations in several countries, with high level executives, and when we asked the company about it, they didn’t have any answers,” she says. “We excluded them in 2005. Two years later, they started talking to us about what they were doing to remedy it and in 2009 they were reincluded with best practice anti-corruption systems.”
Another example is an Asian shipping company that had been transporting phosphates from disputed Western Sahara, in breach of international humanitarian law. “We asked them if they were aware of being in breach,” says Meisingset. “Two weeks later they said ‘we quit this business’.”
Amundi had a similar success with a Chinese company it rated G (its lowest score, now excluded across Amundi) because of conditions for its workers. “I emailed them two years ago saying ‘you face some strong human rights issues’,” says Sorange. “They never responded. Three months ago they sent an email saying they were ready to talk.”
| Next big step: responsible investing goes transparent | ||
Enthusiasts for responsible investing may be on the verge of a big step forward. In Cape Town on September 30, the UN PRI will unveil its new Reporting and Assessment framework. Every year since 2007, PRI signatories have had to fill in a questionnaire detailing what they were doing to implement the principles. Those who refused were delisted from the group. But the signatories did not have to disclose the contents of their reports to the public. About half of them disclosed the results voluntarily. “Fund managers could have glossy responsible investing brochures, but focus only on one asset class, or only in one country,” says James Gifford, executive director of the UN PRI. “Most of the signatories are still at an early stage. There’s nothing wrong with that — everybody started with one person. It’s not that they’re doing anything bad, they’re just not doing anything proactively responsible.” A gentle approach was necessary in the PRI’s early years, to get the mainstream investment industry on board. The principles were deliberately worded quite softly. Now, after a big consultation process, the initiative is ready to get a bit tougher. From 2014, signatories will have to disclose their reports. The questionnaires have also been changed to include more purely factual data. This can be independently assessed, and will allow comparison between managers. Gifford believes this annual exercise could become the single most important driver of responsible investment in the medium term. Asset owners will use it to evaluate asset managers, while asset management staff will be able to go to their CEO and ask for resources to improve their ranking. |
||
