Climate Change 2011 Part 7 - Growth drivers

Lars Kalbreier

It is a journey. Are we at the beginning, the middle or the end of the journey? I would probably say that we are more towards the beginning than the end.

Viktor Andersson

It is far easier to find companies talking about the benefits of sustainability. The question is finding a fund manager who talks to about it. If you talk to any mainstream portfolio manager, they just say, ‘Yes, well, sustainability is interesting, but I don’t see the added value’. If you talk to Unilever’s Investor Relations people, they can say, ‘This is how much money we are making from sustainability, this is how our sustainability program increases the value of our company’.

Elisa Trovato

Matt, what are the initiatives at European level that push for more transparency in the way companies operate in the sustainability space? Can these initiatives contribute to increase the universe of sustainable stocks and investors’ awareness on this topic?

Matt Christensen

I think a lot of companies do a fair amount already, but what is needed is to help them understand what would be the most useful data to report on and to talk about, beyond what every group is asking. A lot of stakeholders want to have different information, so between questionnaire fatigue and the lack of questions from investors, I think we have two extremes sometimes. If done correctly, the help on the regulatory front would be to provide some ideas on the critical-path information on an obligatory and mandatory basis that companies should report on, so that people can start to compare it. Then you might have a portfolio manager who says, ‘Now that I have a data point, I can compare, across the sector, this aspect of the ESG agenda’, but until there is the ability to do comparisons over time that have relevance, it is hard to find enough where you are comparing oranges.

Viktor Andersson

Of course, it would be helpful, but changing the way portfolio managers work is not just providing them with the data. The main conundrum for ESG integration is that, in general, a portfolio manager has the investment model that they believe is the best. They take the factors that they believe are the most relevant to come up with a fair price; otherwise, they would take other factors. Coming in from the side – which is what ESG often is – and convincing the portfolio manager, ‘Actually, you have not been looking at all the relevant factors. You forgot these three’, is a challenge. To say the least.

Matt Christensen

If companies had to report, however, on more comparable criteria, it might be easier to see the relevance of the data.

Viktor Andersson

It would help the believers, but I do not think that you would convert the non-believers.

Matt Christensen

Until they saw that it mattered, I agree, but if, over time, those models showed that it mattered, they could be converted.

Viktor Andersson

Interestingly, a couple of emerging-market stock exchanges are leading developed-market stock exchanges in terms of implementing listing criteria requiring disclosure of ESG information.

Elisa Trovato

The reputational risks of poor ethical standards are obvious but do you believe that the impact of the positive attributes are harder to quantify?

Joost Bergsma

The positives, I agree, are difficult to measure transparently. In terms of the negatives, you can see what happened to BP. If you do not comply, there are significant negative consequences that could be relatively long-lasting. That stick approach, as opposed to a carrot approach, does help companies to drive forward in terms of being more compliant and being leaders as opposed to laggards, or just ticking boxes.

Elisa Trovato

What are the key growth drivers for sustainable investing, and what are the barriers to overcome?

Viktor Andersson

Clients expect asset owners and asset managers to start integrating ESG into all asset classes. Five years ago the leaders were already well ahead in terms of global, large-cap equities. Now, they are looking into emerging markets, fixed income and alternative investments, and that is what is driving the growth currently. Investors cannot, year after year, report that they are working on (the same) global large-caps. They have to show progress, that they are going down in market-cap size and expanding into other markets and asset classes. I would say that that is the main driver.

The main barrier for doing this properly is that a lot of ESG teams are still separate from the portfolio management process. In many companies, ESG teams are a separate team sitting in separate room, far from the actual investments, providing the portfolio manager with an investible universe with which to work with, and that’s it. At the same time, the portfolio manager is doing something else with the mainstream portfolio, which is much larger, so they pay more attention to that. That is also why SRI might in some cases underperform: because it does not get the attention that the mainstream portfolio gets.

Carlos Joly

I think a point of departure is to acknowledge that the investing public intuitively understands that environmental issues, and particularly climate change, are important to investment decisions and to the future of their investments. Given that the investment public intuitively understands that, why is it not more widespread? The reason has to do with two factors of our investment business: one has to do with what I call the investment technology, in that we are still too wedded to using and promoting passive investment strategies, rather than having real conviction funds that are not tied to tracking error. Even though we know that there is institutional demand for passive investment strategies, we do not do enough to persuade those from whom the demand comes that that is not really the way to go. The world has changed. The new normal is not the old normal, and that applies not just to the frequency of financial crises, but also to environmental and social factors, and their impact on the investment proposition.

The other internal factor to our business that constitutes a barrier is that, in many cases, senior management is not making the right decision, which is to put the marketing and sales budgets and the salesforce behind the promotion of ESG-type funds. Like most things, these funds do not sell themselves – they have to be sold. When that happens, I have no doubt that there will be exponential growth in ESG-type products. So far, at least in France, it is largely an institutionally driven market, but I believe there is untapped potential to expand the market to the investing public.

Joost Bergsma

In terms of growth, I think the train definitely left the station a long time ago and gained pace over the last few years, and now is unstoppable. In that sense, I think that ESG is on a path to really becoming mainstream. It probably is not mainstream today but, five or 10 years from now, it will be. Within that, there might be subsets, but it is on the way to becoming mainstream. The reason why it is growing is that there is a fundamental economic benefit to complying with ESG. It can be seen clearly in terms of climate change in the sense that energy is running out, and energy security is a key driver for it. There is a growing demand for transparency, which has a knock-on effect on more transparent governance that is happening today. Certainly post the financial crisis, it has intensified. These key growth drivers of ESG are here, and will only become more vocal, which will drive the investment universe.

Clearly, there are barriers. We talked about sales, and training is key. A bit more of a regulatory push can help too. It is important for corporate governance to have clear standards as to how to compare and measure impact. An important point on the product side is that, while we have talked a lot about listed products, today there are certainly many unlisted, illiquid-type opportunities, which can be a barrier for private clients, given that, over the last two years, few people wanted to invest in anything that was illiquid. It is about product innovation: taking illiquid opportunities such as clean energy and developing simple financial instruments to make them liquid. This will help the growing demand from private clients.

Elisa Trovato

We have not talked about carbon trading or carbon capture and storage as an industry. Do you reckon it is going to grow?

Joost Bergsma

Absolutely, they will certainly grow, but we need more regulatory incentives. In addition, we need more clarity in terms of the cost of not doing it or of producing more carbon. These kinds of issues need to be more transparent. The mainstream technologies of clean energy today are solar and wind; the next generation just requires a further regulatory push, which includes things like carbon storage and so on, but they will come, for sure.

Steve Triantafilidis

I think most of the points on the growth drivers were mentioned, including that there is a clear demand and, therefore, higher growth rates. In terms of scarcity of resources, UNPRI, to some extent, has certainly driven this, and other things like the UK Stewardship Code. There is also some impact from the financial crisis, not in the environmental space but in terms of social issues and governance, that has highlighted that this is an area there should be more focus on. If companies and investors had perhaps thought about those factors differently, they might have avoided some, if not all, of the problems of the crisis.

In terms of barriers, we mentioned performance perceptions, which is something that is ongoing. The different terminology is something that we have been quite focused on: what does it really mean when people use different terms? There are also different approaches within that, so there is some investor confusion when someone comes with a sustainable product as to what the different terms mean. In terms of traditional investment approaches, most people have a clear idea of what value investing or growth investing mean; even if asset managers have a slightly different interpretation, they more or less have a common understanding. In sustainability, they do not. There are also difficulties in introducing other asset classes into the alternative space. Commodities are a big area of investing, but what does it mean when we look at it there?

Something that has not been mentioned is the fact that, in most markets generally, hedge funds account for as much as 40-550 per cent of trading, which is disproportionate to their asset size; therefore, they are a key driver in terms of what happens to share prices even longer-term as well. From my observation, this is not something that I have ever heard hedge funds talk about when they present their investment approaches. If a large category of trading is being done by hedge funds that are not even focused on that, that will be a significant barrier to the mainstream adoption of sustainable investment.

Andreas Knoerzer

In terms of growth drivers and barrier, in reference to private banking, I do not believe that legislation is a driver, particularly if you talk about doing business with private individuals. I also believe that, on average, the products are there. There are a few gaps here and there, but generally we do have the products. I do not believe that, for private individuals, definitions matter. There are different methodologies that should be applied, because that is the market. Ultimately, it is about our building up a track record. If you have a track record, you have a story to tell and to sell.

Elisa Trovato

Matt, from a regulatory standpoint, what have been the most successful initiatives that have been taken by the European Union, and which ones should be implemented in the future?

Matt Christensen

The EU has not done anything particularly helpful for ESG yet, so I cannot point to one. I can point to nation states that I think have done some interesting things. The easiest way for a regulator to approach this area is on the transparency side, because the minute you start working through definitions like ‘sustainability investing means x from a regulatory perspective’, you destroy the sector. Doing it through disclosure regulation is a nice way to make a gentle push that alerts people to get engaged and to try to find ways of making disclosure a strategic issue, not a compliance issue.

The other point related to that is that people often talk about the challenge in this space: how do you define sustainability and ESG etc? It is very difficult. What can be done, though, and should be at least tackled, is common language. Whether you can develop common language across different cultures and values – and I see this on a daily basis, given that I visit different countries and talk about this – is still a question mark. If we were, however, able to develop a common language for how we talk about ESG, that could only help in addressing clarity for everyone – regulators, investors and private wealth – because there is still this overall question of, ‘I do not understand the terminology. A lot of terms are used in different ways in different countries’.

Eurosif is embarking on that this year. From a study that we did on sustainability investing, we saw that it has grown a lot, but what has not really happened is some clarity around what it means. With all this growth, there are a number of fallout potentials coming out from it. The number of people doing integration seems awfully big, but what is that anyway?

Anything that we can do to try to help that side would be hugely beneficial, although I do not expect to ever reach 100 per cent of the answer. We are running a consultation asking investors across Europe to have meetings to discuss it. We put together a working group on this, from a European perspective first.

We are not necessarily seeking to reach a new market, because that market is actually happening. It is by developing better clarity that that new market will also help make people feel more comfortable as a relationship manager addressing what they want to talk about that they often have a fear of, due to a lack of clarity and common language. In terms of new countries, we are doing a lot of work with new countries and meeting with investors there.

Elisa Trovato

Lars, is this confusion in terminology going to hinder the development of sustainable investing. What should be done to increase investors’ interest?

Lars Kalbreier

We all agree that there continues to be an opportunity here, so nobody has given up on SRI as such. Every year, it is growing and becoming more prominent and more mainstream. Having said that, the most important denominator that I see for the widespread use of SRI criteria is probably a common understanding of what it is. Fifteen to 20 years ago, before the existence of globally acknowledged accounting standards, everybody had different ways of calculating their earnings, and it was impossible to compare, say, a German company with a French one. I was very encouraged when Matt said that they are now trying to put that together around common measures. They have been able to do that in the accounting world, where we can now compare a European company with one in the US, and take investment decisions on a global basis. The next step – and the biggest driver – would be to start doing that in the SRI space too, to have a common methodology and to come up with a clear set of rules or recommendations around how a company can score against SRI criteria. If that happens, it will be much easier for portfolio managers and analysts to start quantifying it and making it an additional factor in the model. It will never be the only factor, but it should start to become part of the investment process.

Carlos Joly

As Matt says, it would help avoid confusion if we could develop a common language. So let me give it a try. For people who are not familiar with our space in the investment industry, the terms sustainable investing, responsible investing, ESG, SRI, and ethical investing, may seem to be referring to the same thing. But there are clear distinctions and our industry could do a better job of explaining the distinction. It is not that complicated. Ethical investing has its distinct roots in negative screening, so I do not see why negative screening cannot be made synonymous with the term ethical investing. That would be the first category, applying primarily to the technique of negative screening. Then you have the second category, the different ways of doing positive selection from a universe of stocks or bonds. Operationally, that requires scoring and ranking companies based on a range of environmental, social and corporate governance criteria (ESG), and the construction of portfolios based on or taking into account those rankings—as well as taking into account financial analysis. Those portfolios can be either high conviction portfolios, when they ignore tracking error constraints or allow very large tracking errors, or they can be near-index portfolios when they impose narrow tracking error constraints, as is unfortunately too often the case in my view. The third category, then, is thematic investing, which is very clear: one defines a theme, as Natixis Asset Management has done with climate change, and one picks companies and sectors that are responsive to that theme and to your process of financial analysis, and you do not generally score companies intra-sector on the whole range of ESG factors. Around this table, we could decide to speak in those terms, if we wanted, which would help avoid confusion between us. Personally, I try to avoid the use of terms like ´sustainable investing` or `responsible investing, except perhaps when talking in an aspirational mode, because they are really devoid of operational content and too easily misused.

Andreas Knoerzer

You have the mix too, because you can still score and still have themes.

Carlos Joly

That´s true, Andreas, there are of course interesting hybrids. And we also have the use of engagement, which we have not taken up in this discussion. If done seriously and in concert it has the potential to influence the environmental and/or social behaviour of companies in a positive direction. In any event, we could agree on the terms we use to refer to the three broad categories that make up the landscape.