Using environmental, social and governance factors to protect client portfolios

Q If a client comes to you and says: ‘What is the difference between SRI, ESG and impact investing?’ what do you tell them?

A There is a lot of confusion behind those abbreviations. Impact investing means that when investing in companies, your first objective is to generate a positive impact either in the social or environmental space. You want to fight global warming, for example. You want to help people to get access to education, to healthcare or to food. The financial return comes second. 

On the contrary, environmental, social and governance (ESG) takes more of a risk approach and it is about integrating the environmental, social, and governance risk when investing in companies. It’s an extended way of assessing corporates, and, of course, to avoid serious controversies related to ESG like infringement of human or social rights.

Socially responsible investing (SRI) is in between. It is about generating an impact but also to obtain the highest financial return. Unlike ESG, in SRI some companies or sectors are excluded.

Q  The latest statistics from the Novethic Research Centre show that there’s €223bn invested in socially responsible investments in France alone, with a 31 per cent year on year rise and the ESG figures are similarly impressive. What is accounting for this massive rise?

A Firstly, regulators encourage or even push asset owners to master the ESG risks of their investments, and integrate more and more ESG in stock picking and portfolio management. 

Secondly, we have a new kind of institutional investor. Traditionally asset owners have been more into SRI funds, using their own values and criteria to exclude some sectors or companies. Now, they are aligning with this big trend of ESG integration, mainly to comply with regulation. This enables them to give some proof or evidence that they have been investigating the risks in portfolios.

Q  Money is coming in, but is there concrete evidence that including ESG factors actually improves investment performance?

A SRI does not destroy value. On the contrary, excluding the bad companies and incorporating ESG factors can help at least safeguard your investments. Does it create value? That really depends on the way you manage strategies. 

At BNP Paribas, we have a 10-year track record and experience to prove they can also overperform traditional indices. It really depends on the portfolio manager. If you have a good portfolio manager with the addition of this ESG toolbox, you can understand better the risk of the companies you invest in, and also identify new growth ideas and promising activities, to address issues such as climate change or demographic challenges. 

Q  Have we seen a huge change in the development of this sector which once concentrated on avoiding investment in arms and tobacco, and now looks at a much broader range of different factors?

A  Yes, the market is changing and evolving. Traditionally, we used to link responsible investment with negative screening, with excluding companies or controversial sectors. It was more ‘ethical investment’. Alcohol, tobacco and gambling are still a big part of  the business world, especially in the Anglo-Saxon world, but what we have been witnessing over the last five to 10 years is a shift towards positive screening. Investors want to invest in the most robust companies. For us, those are companies that manage their ESG impact in the best way. 

Now the big trend is more about protecting clients from reputational risks. 

In today’s internet age, all controversies are made public at the very moment they happen. Investors don’t want to invest in companies that hit the headlines because of the negative impact of their activity. 

Institutional investors also want to be active in changing society and demonstrate that they are part of the solution of the  challenges the world faces. We want to concentrate our investment in companies that are part of the solutions, that provide the best products and services and we don’t want to invest in the companies that are still stuck in the old-fashioned way of managing their business.

Q ESG investing is becoming much more important for institutions but retail clients seem to have fallen a bit behind. Why is there less of an interest for retail clients? Do you think there will be initiatives on that side: new products, new strategies for them? Will the interest there increase as well? 

A You’re right. Retail is the next big target for all asset managers concerned with SRI. There are some reasons why we have not been exploring this market yet. Firstly, it’s difficult to explain the meaning of SRI without going into great detail. 

On the contrary, institutional investors have the knowledge, the understanding and the expertise. And they really take time to clearly understand what lies behind SRI and ESG. But that doesn’t mean that we have forgotten about the retail market. 

We wanted to be innovative, to think about new ways to invest in specific products that could be appealing to the average man on the street. Funds like the environmental thematic funds are now a big success in our retail network. And we are now promoting new funds, more socially orientated strategies, like human development. This means access to food, education, and addressing the big demographic and health challenges of modern society, such obesity.

One of our strategies covers green building. Investors are more and more interested in taking part in the big changes affecting the construction industry, where there are interesting solutions and technologies to help buildings and facilities reduce their CO2 emissions.

Q  Thematic strategies have been important for private banks, although they haven’t really been marketed in an ESG format. Do you expect a change in the slant of the marketing private banks and wealth managers will adopt to promote a thematic strategy that is also ESG compliant?

A Private banks had this proximity with a client that helped them to really tailor the strategies to their need. But the big difference between a thematic fund and an SRI, or a responsible thematic fund, is the former can invest in a theme without ensuring the companies it invests in are not involved in any ESG controversies. Using this extra layer of responsible investing enables you to check the companies that constitute your investments are not involved in human or labour rights infringement, or are not heavy polluters. 

Q  In the future, do you expect ESG criteria to become more important in emerging markets as well? It can be more difficult to adhere to those criteria there. For instance, there might be countries that there are sanctions against, and we’ve seen sanctions against Russia, against Iran. Does that make it more tricky to impose the ESG criteria?

A We used to say emerging countries had the worst ESG practices, so there was no interest in investing in companies in that part of the world. But things are changing very rapidly. Everybody is aware of the heavy pollution afflicting cities in China. The Chinese government has implemented very brave plans to change the situation, including more stringent regulation, to make sure that companies are applying very strict ESG or environmental control of their activities. 

Many governments in the emerging world have strengthened their regulation. Several countries including Malaysia, have taken inspiration from the UK Stewardship Code – a reference  for corporate governance best practices – to improve their corporate governance principles and best practices for companies. 

More and more companies in the emerging world now have at least at the same level of best practices as some European companies. This means we can invest in some interesting companies all over the world. 

With regards to sanctions against countries, it really depends on clients. Some are willing to exclude some countries, such as Russia. Others prefer to exclude parts of the world such as the occupied territories between Israel and Palestine. One of the strengths of the ESG approach is to be a flexible enough toolbox to comply with clients’ requirements.

Q  Do you feel that institutions can increasingly influence the governance of companies and the policies of some regimes?

A This is now the big new trend in the market – it’s only been around for the past three to five years. Institutional clients are more and more pushy and want asset managers to be intermediaries between them and the companies they invest in. They want us to promote engagement with companies as they consider it is part of their role, of their fiduciary duty to promote sustainable development.

Engagement is a good way to start a dialogue with the companies and make them aware of best environmental, social or governance practices in their field or industry. The next step is to then help them work on how to make progress, in order to align with best practices.

When you engage with companies, you can collect ESG information about their practices, have a better understanding on how they perform, how they are managed. It’s a virtual circle because the more you know about the companies, the more aware and informed your portfolio manager is. Thus, the higher return you can expect when your manager implements an effective stock picking and investment strategy for their portfolios.