WITH the rise and rise of new sustainable funds, the question of how to avoid greenwashing becomes more prevalent. SRI (socially responsible investment) labels are popping up and the EU is in the process of defining an ecolabel. In Asia, the Hong Kong's Securities and Futures Commission announced in April this year, new rules that require environmental, social and governance (ESG) funds to justify their green credentials, by providing documents to investors that describe their investment focus, their selection criteria and evaluation methodology, among others. Whereas in the past, a fund would simply be labelled (socially) responsible or not, the market is now distinguishing between different ways of implementing sustainability.
Let's start with the easy part: strategies that only apply simple exclusions and are still labelled as being sustainable should be a thing of the past. Investing sustainably is also much more difficult than buying a set of ESG scores and applying it to a portfolio. There is more to sustainable investing. Let's talk about the new ways of sustainable investing, and the 'greenwashing' dilemmas.
Areas to avoid
There are clearly areas that sustainable investors want to avoid, such as tobacco, weapons, breaches of labour standards and human rights, and certain types of fossil fuels like thermal coal. Other areas are less clear. Traditional fossil fuels, for example, are a big contributor to climate change. However, they are still widely used and needed. There are those who believe that energy companies are both part of the problem and the solution. Others simply want to avoid them. The question is whether being invested in those companies and engaging with them might be a better way of creating change than avoiding them all.
Integrated thinking
Secondly, in my opinion, a strategy is only sustainable if it is also financially sustainable. So, integrated thinking is important. How do long-term ESG trends and external costs such as climate change, loss of biodiversity and rising inequality lead to changes in business models? ESG investing no longer means only reducing an investment universe to the 'best-scoring' names. It means thinking hard about sustainability and how it affects companies and investment strategies.
To give an example: in all our quantitative strategies, if two stocks have equal (financial) factor scores, the one with the better ESG score will have a higher weight. In our fundamental strategies, ESG will affect the valuation, that is, the target price.
Structurally integrating ESG information into the investment process helps our teams make better decisions. It does not, however, reduce the universe, and they are still allowed to invest in companies with low ESG scores so long as they believe that the risks are more than priced into the market. In our global equity fund, we saw that over the last two years, about 75 per cent of valuations were adjusted after factoring in ESG criteria. This ESG integration combined with the exclusion of tobacco and controversial weapons contributed about 22 per cent of the outperformance seen over the 2017-2018 period.
This method of integrating ESG, although infinitely more difficult and profound in its application than only using ESG scores to reduce the universe, is often not categorised as a sustainable strategy. Clients who want to invest in sustainable strategies simply do not want to invest in 'bad' ESG companies, even if this is already reflected in the share price.
Resources and research
Now, this all requires dedicated resources and research. If you ask an investment team to add ESG to their process, you need to give them the resources and knowledge to be able to do so. There is a wealth of ESG data around, so being able to understand and judge this data is most important.
Let's use an example to explain, by comparing the carbon footprint of two mobile phone companies. Imagine that one company has outsourced all its operations, while the other is vertically integrated. The first one has a low carbon footprint and the other has one that it is much higher. This is an illusion: of course, making a mobile phone creates more or less the same carbon footprint. This is not visible in the data, but requires knowledge and judgement to see that it is there. If you have no resources committed to looking at this, and analysts do not have access to sensible research or an understanding of these issues, you will not be able to structurally integrate sustainability.
Active ownership
Another way of implementing sustainability is through active ownership. At Robeco, we have been an active owner for 15 years. Last year, our team of 13 dedicated specialists engaged with 214 companies. The engagement takes place over a three-year period, allowing us to track and measure the progress of companies. Some asset managers claim to engage with 2,000 companies per year. In my opinion, that cannot be more than asking one or two questions on ESG at a regular meeting, or sending a standard letter. You need to have substantial resources in place to be able to do this in a credible way.
Voting behaviour is also interesting. Research shows that some of the larger (passive) investors almost always vote with a management's recommendation, even on shareholder proposals relating to environmental and social issues. That doubts the credibility of that manager, I think. We see that social and environmental shareholder proposals are becoming better formulated and more in line with long-term shareholder value creation. So, last year we voted in favour of those proposals in 72 per cent and 78 per cent of the cases, respectively.
Walking the talk
This brings me to my key point: walking the talk. How credible is a fund provider if they provide a few very good SI (sustainable investment) funds, but are not doing anything in their other products, or in their own operations, such as the voting behaviour I mentioned earlier?
Lastly, a quick word about labelling. They could provide valuable guidance and a stamp of approval for a fund, which would be good for retail investors. Current labels do differ in their approach though. That is most likely because approaches to sustainability investing differ so much, which means that asset managers still need to do their own research. Ultimately, transparency, not labels, is most important: asset managers need to clearly show what is and what is not part of the strategy of the fund, no matter whether it is called sustainable or responsible, or something else.
- The writer is head of ESG, Robeco
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