“ESG investing” is on the tip of everyone’s tongues. The Environmental, Social and Governance factors are aspects used to measure the sustainability of a company or a business, as we addressed in a previous article, “Addressing the Basics of ESG”.
If you Google “ESG investing”, you would come across definitions that list it as a form of “sustainable investing”, and that a variety of approaches are used by different companies, organisations and asset management firms globally, which can be rather confusing to someone unfamiliar. So as a start, let’s get acquainted with these 3 common approaches adopted by various institutions:
1. ESG as a framework to select firms to invest in
The concept of sustainable investing is already common practice in Europe, and several asset managers include ESG investment principles as a guiding framework when selecting and analyzing companies to include in their investment universe or products. Stricter firms may even consider removing companies who do not meet the ESG criteria from their investment universe entirely. Others, may take the process as part of their due diligence to understand their underlying holdings better.
In a separate report published in 2018, as compared to the situation in Europe, where an approximate 53% of total assets managed in 2016 are classified under sustainable investing, the practice is still a minority in Asia-ex Japan, at a very low 0.8%[1]
The Global Sustainable Investment Alliance Review (“GSIA Review”) 2018 measuring the growth of sustainable investments, found that the below regions achieved at least 2-digit growth in a span of 2 years. In contrast to the above findings on Asia-ex Japan region, Japan in particular, achieved a significant growth of four-fold over the two year period, albeit coming in from a low base. This may suggest asset managers based in Asia are now starting to pay more attention to sustainable investing.
|
Region |
2016 (USD billions) |
2018 (USD billions) |
% Change |
|
Europe |
$ 12,040 |
$ 14,075 |
17% |
|
United States |
$ 8,723 |
$ 11,995 |
38% |
|
Japan |
$ 474 |
$ 2,180 |
360% |
|
Canada |
$ 1,086 |
$ 1,699 |
56% |
|
Australia/ New Zealand |
$ 516 |
$ 734 |
42% |
|
|
$ 22,838 |
$ 30,683 |
|
Source: GSIA Review, 2018
On the other end of the spectrum, as shown in the above table, European asset managers are the biggest contributors in the universe of sustainable investment, and there are various big names within the industry that have been successfully incorporating elements of sustainable investing in their products and investment process.
For instance, French asset manager BNP Paribas Asset Management (“BNPP AM”), which has picked up various sustainability awards in Europe, aims to achieve long-term sustainable investment returns for their clients. As such, sustainable practices are a huge factor in their investment decision process – prompting them to launch a sustainable investment framework – Global Sustainability Strategy (GSS).
BNPP AM's GSS comprises of 4 sustainable components. ESG is just one of these, as you will find in their GSS framework below:
Source: BNPP AM, 2019
BNPP AM takes on the approach of using ESG as a way of making better informed decisions instead of limiting their investment universe. With this information, they actively engage companies with low scores to help them improve their sustainability practices. However, should this fall through, the asset manager may choose to disinvest holdings in the companies.
The process of moving into sustainability is ever-evolving as firms constantly review their practices to do better. The GSS framework is currently applied to the majority of BNPP AM’s funds, and they aim to apply this to 100% of their actively managed funds by 2020.
Just as how BNPP AM have established their own framework relevant to their values and investment decision process, other asset managers have also developed their unique frameworks accordingly.
2. Developing products that support sustainability causes
An increasing number of product managers are developing thematic funds or ETFs with:
- a focus on companies actively striving towards creating ESG impact;
- business models and operations dedicated to supporting the causes of ESG and/or;
- are a part of an industry that has a sustainability impact – e.g. water, education, climate change
Another French manager, Amundi Asset Management, through its wholly-owned subsidiary, CPR Asset Management, launched several new funds in late 2018, investing in themes such as climate change, education and food.
Driven by a strong ESG interest and the knowledge that investments into lifelong education and farm-to-fork ecosystem has a direct and positive impact on society (and are in line with the United Nation’s goals), Amundi and CPR saw a need to establish such funds.
Take their Education fund, which invests in an ecosystem centered on lifelong education as an example. This was developed for a few reasons:
- To offer a positive impact on society: reduces inequality, improves health and well-being, contributes to economic growth, in line with UN Sustainable Development Goals
- There are long-term drivers: global growth, burgeoning middle class, evolving socio-cultural norms which lead to the increasing demand for education
- Opportunity for financial alpha: the booming demand coupled with technological innovations will lead to new educational programs, learning methods and professional development which need to be supported
As at June 2019, the fund has already contributed societal impact in the following areas:
Source: Amundi Asset Management, 2019
Such thematic funds will continue to grow in popularity, as more asset managers and investors begin to appreciate their benefits. During the year of 2019, we have also seen a marked increase in ESG-related funds on our platform, as asset managers become increasingly conscious of the importance (and popularity) of sustainable investing.
3. Firms refining their own practices to contribute towards sustainability
Corporations, on their own, can adopt and incorporate elements of ESG in their day-to-day operations, including refusing support to activities not in line with ESG principles.
Take the case of the coal industry as an example. Investors and institutions have long regarded it as a foolproof investment because of its ability to provide cheap power to developing nations in Southeast Asia (“SEA”), thus riding on SEA’s economic expansion and its increasing need for electric power.
However, it is also well known that the coal industry has a large negative impact on the environment, from its extraction process to the burning of it. With growing pressure from investors, environmental groups and the general public, there are an increasing number of banks, including Sumitomo Mitsui Trust Bank, DBS, OCBC and UOB, that have declared their decision to stop providing loans to the coal industry. This decision is also backed by financial and economic reasons, as evident in a comment made by Mic Kang, a Vice President at Moody’s, where he stated "the declining costs of renewables and the development of disruptive technologies will increase the long-term risk of coal-fired generators becoming uneconomic to run."
Some banks have gone down the other end of the spectrum, and instead of purely withdrawing financing to companies that are non-compliant in terms of sustainability, they now provide financing to sustainable companies, through the issuance of green bonds, or more generally, ESG lending. Note that there are differences to these terms:
- Green bonds: The use of the monies are prescribed for a sustainable cause – climate and environmental projects. Returns for investors may not differ too much from standard investment grade bonds.
- ESG lending: The lender typically provides the loan starting at a standard loan rate. Instead of tying the use of the loan to a green, or specific cause, the lender offers a lower rate if the borrower manages to meet a sustainability target. This could be in the form of helping a defined number of unemployed residents find work, improving sustainability rankings, reducing food wastage and so on.
In early 2019, Xylem (NYSE: XYL), a global water technology company based in the USA received USD 800 million in a revolving credit facility tied to a sustainability rating from Sustainalytics - an independent global provider of ESG ratings. Essentially by improving these ratings, Xylem would be able to reduce their loan interest rate by as much as 5 basis points, providing them with a financial incentive to become more sustainable.
The sustainable movement is growing
Consumer behaviour is constantly changing and evolving, and with the focus shifting towards sustainability, brand loyalty may start to wane for incumbents when consumers are made aware of their lack of sustainable practices.
Just as Greta Thunberg’s Facebook followers continue to increase, the demand for sustainable products and sustainable companies are growing as well. Companies who leverage on this paradigm shift in consumer demands are likely to see their bottom-line increase. On the other hand, those who refuse to act will start to face mounting public pressure, and they may even face regulatory troubles if they engage in highly questionable practices.
Asset managers and wealth managers are now even more aware of the changing preferences and are starting to drive the institutional growth in sustainable assets. In the 2018 review report mentioned earlier, GSIA reported a cumulative 30.4% growth in sustainable investments across the globe in between 2016 and 2017 – and we foresee this number will continue to be on a rising trend.
For investors, if you are not already caught on, it is not too late to get yourself familiarised with this increasingly prevalent approach to assess the investment thesis and sustainability of individual companies.
This is why we are starting a brand new series on understanding ESG investing. In the upcoming articles, we will also be sharing with you on the following topics:
- Why ESG has grown in popularity;
- How ESG can impact a firm’s bottom-line;
- Who is influencing and driving ESG; and
- How you too, can get in on ESG investing.
[1] Driving ESG Investing in Asia (2018), Oliver Wyman
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