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MIND THE GAP

Sustainable investments come into their own

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Now, more than ever, the urgency of climate change and the ravages of unmitigated global warming are front and centre of investors' consciousness.

NOW, more than ever, the urgency of climate change and the ravages of unmitigated global warming are front and centre of investors' consciousness.

Compared to a decade or two ago, the broad category of sustainable investments (SI) has arguably come into its own, whether it is in the form of funds carrying an explicit sustainability theme or the integration of ESG (environmental, social and governance) factors into fund management.

The latest 2018 edition of the biennial Global Sustainable Investment Review finds total assets in SI globally of US$30.7 trillion, a rise of 34 per cent from the previous 2016 review.

According to the report by the Global Sustainable Investment Alliance, responsible investments are now a "major force" across global markets. They command a sizable share of professionally managed assets, ranging from 18 per cent in Japan to 63 per cent in Australia and New Zealand.

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The universe of SI funds covered in the study runs a gamut of approaches, ranging from negative screening and best-in-class to ESG integration, SI-themed investments and corporate engagement.

Traction is expected to grow. A survey by Allianz Global Investors of institutions found that 71 per cent hope to manage all portfolios in an "ESG-conscious" way by 2030, compared to just one per cent today.

For Singapore-based investors, the good news is there is no shortage of SI options that reflect one's values, although explicitly themed investments such as clean energy and water may be fewer. Still, there are some funds with a long track record of over 10 years.

The big question among investors is whether they need to sacrifice return for the sake of sustainability. A survey of European professional investors by NN Investment Partners found that 52 per cent believe they must sacrifice returns to invest responsibly. They are willing, in fact, to give up an average of 2.4 per cent in return in order to have a positive ESG impact. One in 10 said they would forgo as much as 4 to 5 per cent a year.

Fortunately this may not be necessary, even though SI investments are not immune to market volatility or to specific sector risks. A white paper by Morgan Stanley compares the performance of over 10,700 traditional and Sl funds between 2004 and 2018, based on total return and downside deviation.

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The study concluded that there is no financial trade-off in the returns of sustainable funds compared to traditional funds. It also concludes that sustainable funds may offer lower market risk; their downside deviation is 20 per cent smaller than traditional funds, a consistent and statistically significant finding. This significantly smaller downside deviation for sustainable funds held even in turbulent years such as 2008, 2009, 2015 and 2018. Specifically in the last quarter of 2018 when volatility spiked, the median sustainable fund outperformed the median traditional fund by 1.39 per cent in US equities.

Global managers with a presence in Singapore affirm their commitment to expand in SI and ESG integration. JP Morgan Asset Management's Jennifer Wu was hired less than a year ago as global head of sustainable investing. While her team is currently small, she has formed a sustainable investment leadership team of 33 people within the firm, including the global head of fixed income research and portfolio managers, among others, to serve as a board of advisers and as "my ESG champions to cascade everything".

ESG data on companies, she says, helps managers to identify risks and may also help to generate alpha. "Most sustainable funds today are based on exclusion which may not be a good idea for some investors... One approach is best-in-class which identifies across all sectors the companies that do better on ESG issues."

Fidelity International recently launched proprietary sustainability ratings that seek to provide a forward-looking view of a company's trajectory on ESG-related issues. Companies are graded on a scale of A to E, focusing on awareness, action, results, and direction of change.

The firm's global head of stewardship and sustainable investing Jenn-Hui Tan says the firm previously relied on third-party ratings which were based on public disclosures. "We could add something extra because we do many company meetings. We had 16,000 meetings with companies last year. We can construct a view of where a company stands on sustainability today and its likely status in the future. We think about change and improvement, where the biggest alpha signal is."

Every fund in Fidelity's sustainable family of funds commits to maintain at least 70 per cent of net assets in companies with good ratings. The remaining 30 per cent may be invested in low-rated companies but with "improving characteristics". The alpha generation, he says, arises from the improving companies. "We then undertake to actively engage with the companies to get them to attain better ratings."

BNP Paribas Asset Management manages roughly 43 billion euros (S$66 billion) in funds with a sustainable theme including "enhanced ESG", thematic and impact funds. This is just over 10 per cent of its global AUM of 421 billion euros.

Earlier this year it committed to a global sustainability strategy which aims to apply SI across all assets and geographies by 2020. Currently its flagship fund range BNP Paribas Funds is 100 per cent sustainable.

Says Gabriel Wilson-Otto, the firm's head of stewardship Asia-Pacific: "We firmly believe ESG considerations shouldn't be limited to pure SRI (socially responsible investing) funds, but should be integral to designing and implementing resilient, future-proof mainstream portfolios... We also believe focusing on ESG considerations can help to unlock upside potential and enlarge the scope of investments."

In its sustainable funds, it undertakes to measure and monitor factors such as the carbon intensity of investments, CO2 emissions per portfolio, the water and forest footprint and the proportion of women on boards. "We believe there is a mispricing of sustainable development by capital markets, which will be shaped by global sustainability challenges in the medium to long term."

The firm has a number of sustainable funds available in Singapore with a high sustainability rating by Morningstar. These include the Global Environment Fund which has outperformed the Morningstar peer category of ecology funds.

AllianzGI's Global Sustainability Equity Fund, incepted in 2003, has had a strong track record. The portfolio invests in about 50 companies and aims to generate capital growth over the long term, while having "a positive and measurable impact on society". Says director and portfolio manager Paul Schofield: "As a team we believe that incorporating ESG analysis is vital when looking for long-term outperformance, because ESG analysis can help to identify positive and negative aspects not always evident to the wider market." The firm uses a proprietary ratings model to measure and track companies' sustainability performance.

Schroders manages some US$2 billion in dedicated ESG funds. It has integrated ESG analysis into a total of about US$211 billion in assets. The firm's total AUM is over US$550 billion.

One of the funds available in Singapore is the Global Climate Change fund; it also has a history of outperformance.

Simon Webber, Schroders lead portfolio manager, says: "While we would ultimately expect stock selection to drive performance of the portfolio through the cycle, the inherently long-dated nature of climate change means that performance will be susceptible in the short term to portfolio tilts... introduced by the theme, such as the substantial exposure to industrial stocks and minimal exposure to healthcare."

He said exposure to a number of names in the electric vehicle supply chain also proved to be a drag. "The industry is facing fundamental challenges in the short term, particularly as China - now the biggest electric-car market in the world - is experiencing a reduction in subsidies. However, we view this phase as more of an air pocket than an indicator of future potential."