SUSTAINABLE investing is often equated with ESG (environmental, social, governance) investing. But are they the same?
For the most part, investing with a consideration for ESG metrics is an exercise in risk management. Companies that rank highly in ESG factors are less likely to incur regulatory penalties, sanctions or legal action, for instance, which may devalue their brands or cause a loss of confidence.
Investors grapple with two big questions: Does ESG investing generate the coveted alpha or returns above the market? Do high ESG scores mean a company is doing good for the environment and society?
On the first issue of alpha, more asset managers are taking pains to dig deeper via engagement and data to find an edge. As for the second question, high ESG rankings do not necessarily result in a greater good.
Lombard Odier Group (LO) managing partner Jean-Pascal Porcherot says there is a distinct difference between ESG investing and sustainability. “ESG seeks to answer one question: How is the company behaving? But on sustainability, we try to answer this: What is the company doing to change its operating model to reach net-zero by 2050? The two questions are very different.’’
Porcherot contends that an ESG approach does not drive returns. “But what companies are doing will drive performance. The question is – how will economies be rewired over the next 10 to 30 years? This is a very complex issue.’’
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Transition investing
Far beyond just ESG analytics, some firms are focusing on the net-zero transition as a pivotal theme. The key is to make sense of how industries and companies will need to shift, adapt, and invest in solutions to aid the transition. The most promising investments may well be found in private markets, via venture capital or private equity.
Porcherot says: “You need to have a critical view of the changes in operating models that corporates will implement over the 20 to 30 years. You cannot think in terms of typical industrial clusters. You need to think about system changes.’’
LO has identified three system changes – electrification; nature; and a focus on materials, mandating a shift away from a linear “make-take-waste’’ economic model towards a circular economy where reduce, reuse and recycling are the norm.
“We translate these system changes into transition roadmaps. We try to model the capex and understand how profit pools will shift. Then we connect the profit pools to investment opportunities. You’ll be able to find names that will generate that green alpha.’’
He believes nature will emerge as an asset class. “Nature is the most underpriced asset today, and it’s critical for our needs. Nature absorbs more than 20 gigatons of carbon every year. The day we start putting a price on it, it will become a big asset class.’’
LO intends to roll out a “nature-based’’ offering for institutions later this year. It has also planned strategies reflecting the system changes. Last year Lombard Odier Investment Managers tied up with the Alliance to End Plastic Waste to raise US$500 million for a private equity circular plastic fund, investing in solutions for plastic waste collection, recycling and technology to improve plastic durability and recyclability. The first round of fundraising has closed.
BlackRock’s Emily Woodland, Apac head of sustainable and transition solutions, says transition investing has three drivers – innovation, government policy, and consumer and investor preferences. Transition isn’t a linear process, she says.
“We expect it to be a multi-speed transition between different regions and sectors, based on the costs and availability and cost of capital.’’ BlackRock has rolled out a transition investing platform with US$100 billion in assets, including public market portfolios, private market funds and transition deals.
Companies that are aligning their business models with decarbonisation, in industries such as metals, utilities and mobility, “could offer some of the most attractive investment opportunities’’. The strategies include a “brown to green’’ materials strategy, investing in undervalued carbon-intensive companies that produce the raw materials and products driving the low-carbon transition.
Private banks say the concept of natural capital finds a ready ear among clients. Mario Knoepfel, UBS head of sustainable investing advisory Asia-Pacific, notes a growing interest in the issues of biodiversity and natural capital. “We’ve seen increased focus on nature-based solutions (NBS) to generate returns for the planet, people and profits. While NBS was traditionally seen as an area for philanthropy, technological and financial innovations are beginning to unlock the scalability and accessibility of these projects to commercial-rate investors.’’
DBS Private Bank’s Marc Lansonneur, head of managed solutions and investment governance, said the bank is “heartened to see more clients rethinking their role in society, and how they can best play their part’’. “Climate-related thematics such as decarbonisation, net zero, renewable energy especially, are topics that clients – who are business owners themselves – also look at in their day-to-day business operations that will bear more measurable impact.’’
ESG-plus
Meanwhile asset managers strive to go beyond standard ESG measurement to eke out value. Here are some highlights:
Fidelity International: The firm focuses on the principle of “double materiality”. Single materiality focuses on the ESG risks and downside that may hit a company’s bottom line. Ellie Tang, the firm’s director for sustainable investing says: “Double materiality looks at these risks and also at how a company is positively contributing to the environment and society.”
“This inside-out and outside-in view allows us to understand how a company’s sustainability performance would look like in the longer term. Coupled with engagement and good communication with investee companies, we get a 360-degree view of companies and their abilities to translate strategy into implementation.’’
Schroders: Mervyn Tang, head of sustainability strategy (Apac), says analysis of climate transition risk involves getting a handle on the challenges businesses face as they move towards a low-carbon regime. Carbon intensity provides insight, but only partially. “Some companies may have more pricing power, allowing them to pass higher carbon costs to their customers.’’
He notes the growing sophistication of sustainable investment themes, such as circular economy, biodiversity and active ownership. “Central to this evolution is measurement. We’re enhancing our methods to quantify the engagement progress and impact. The more we measure, the more transparency we can provide, which mitigates the risk of greenwashing.’’
Wellington Management: Wendy Cromwell, the firm’s head of sustainable investment, says some market inefficiencies support the case for sustainable investing as a source of alpha. These include an excessive focus on short term growth and inconsistent and backward-looking third-party ratings. “Most climate analysis focus on mitigation, rather than adaptation. By focusing on the latter, managers can identify winners that will stand a better chance of thriving in a new climate paradigm.’’
BNP Paribas Asset Management: Crystal Geng, Asia ESG research lead, says the firm’s methodology is “markedly differentiated, with a more focused number of ESG metrics and a clear preference for ‘performance’ over ‘policy’ indicators”. For industries and retail, for instance, the firm looks into indicators for worker mortality rate, accident rate and turnover, instead of just relying on a company’s health and safety policy.
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