It’s all about sustainability… I think?

The current obsession among global investors to invest in assets that meet some or other impact and sustainability measure is somewhat counterintuitive, because it makes no sense to sink your hard-earned cash into a business that is unsustainable and / or managed unsustainably.

This was the Eureka moment that followed my attendance of a discussion titled ‘Keeping up with the sustainability theme’, hosted as part of an Allan Gray local and offshore fund provider showcase. Two experts from the multinational asset management firm, Schroders, were on hand to unpack the evolving sustainable investing landscape and provide clarity on how investors benefit from it.

All money should be managed sustainably, point!

“What is all the fuss with regards to sustainable investing; should this not be how all money is managed rather than there being a special category for this type of investing?” asked Kondi Nkosi, South Africa country head of Schroders. This writer applauded the opening statement enthusiastically, then looked around sheepishly at the walls of his office… after all, there is not much point working oneself into a frenzy during a virtual presentation. Katherine Davidson, portfolio manager and Global Sector Specialist at Schroders was more restrained, claiming that all money would eventually be run sustainably: “In fact, we are already on a very fast trajectory towards [a global sustainable investing] outcome”.

The latest statistics are telling. Europe has been leading the way on sustainable investing, with the latest industry figures showing that over 40% of assets under management (AUM) are already sustainably managed to some degree. And around 80% of global asset managers are committed to integrating environmental, social and governance (ESG) factors in their portfolio management decision making. Davidson said that the sustainability trend was not restricting investor choice. “I do not think that we will just have one homogenous type of fund,” she said. “We will still have different types of products for different kinds of end-investors… and we will end up with a broad spectrum of sustainable funds that focus on different outcomes, from impact through to integration”.

But which fund? Investors paralysed by choice…

The challenge facing retail investors is how to make sense of the sustainability claims or ratings that fund managers attach to their funds. Asset managers are dead keen on getting their slice of the approximately US$600 billion that has flowed to sustainable portfolios over the past few years, with the result that some have overstated the greenness (sic) of their portfolios. This process, called greenwashing, is defined as a form of marketing spin to persuade the public that an organisation’s objectives, policies and products are environmentally sound. It is worth noting that asset managers are as prone to being conned by greenwashing as you or I. They might, for example, invest in a stock after being misled by that firm’s executive team insofar its ESG credentials.

Davidson was quite cynical about greenwashing, given how enthusiastically asset managers were vying for their share of the capital that was seeking sustainable opportunities. “About half of the funds that have been launched in the ESG category have been reclassifications of existing funds, which tells you something about the [sustainability] bandwagon effect and the quality of some of these offerings,” she said. Her advice to end-investors was to interrogate asset managers around their investment methodologies. You will soon get a sense for whether or not an asset manager is passionate about impact and sustainability, and your gut will tell you more about the manager’s approach than some or other sustainability score.

Wishy-washy regulation creates ‘green’ uncertainty

Nkosi steered the discussion towards the lack of suitable definitions for sustainability and what a sustainable fund should be… Who would have thought, for example, that the most recent regulatory guidance on sustainable investing would fail to define the word ‘sustainable’. It emerges that the European Union’s Sustainable Finance Disclosure Regulation (SFDR), in force since around March of last year, makes no attempt at defining the word, leaving each asset manager to independently figure out what ‘sustainable’ means. Take a moment to reflect, dear reader, because that would be like ploughing through a multi-year Retail Distribution Review (RDR) process without deciding what to call the person who offers financial, investment or risk advice! But we digress.

Regulators claim they are trying to make it easier for retail investors to differentiate between sustainable funds; but have done little to create a consistent and comparable sustainability measure. Inconsistency is inevitable, opined Davidson, because some funds are using third party sustainability ratings agencies, of which there are dozens, while others are developing their own proprietary models. “The result is that some asset managers are claiming 100% of their AUM as sustainable while others are more conservative, claiming only 10% or 20%, despite there not being much difference in their underlying strategies,” she said. Another major challenge is that sustainability regulations are being imposed on asset managers before being introduced for the firms they invest in. These issues should resolve with time, but for now some guesswork is necessary!

Give me an ‘E’; give me an ‘S’, or give me a ‘G’

The term ESG is ubiquitous in the sustainable asset management paradigm… At first glance, environment and governance are simple enough to interpret; but the social aspect turns out to be a sprawling mess of customer safety, employee interactions, human rights and supply chain issues, to name a few. In practice an asset manager like Schroders uses a seven-factor stakeholder model to assess a firm’s ESG credentials. “The ‘E’ is the measure where there was never any question, it is now universal,” said Davidson. “But no one can get away from the ‘S’ because every company has a community, customers, employees and suppliers … as for the ‘G’, well that is just part of investing and has been for hundreds of years”.

Schroders uses two approaches to find sustainable companies. The first is to favour companies that are run for the long term. And the second, is to seek out companies that are run for the benefit of their wider stakeholders, not just their shareholders. According to Davidson, there are many brands, domestically and offshore, that have integrated corporate social responsibility and sustainability into their businesses over the past 30 years. “When we talk to their management teams we find that they understand the importance of investing in their workforces and working with their local communities; sustainability is not about profit, but rather built into the business’ DNA,” she said.

Be silent, you sustainability sceptic

“What are some of the reasons that someone might be a bit of a sustainability sceptic and more importantly, what would your response be to someone who holds that view?” asked Nkosi, as the session drew to a close. “It is kind of kind of an anathema in Europe to be a sustainability sceptic, now,” concluded Davidson. “People are sceptics around a particular definition or element of the process of sustainable investing, but when you accept the English definition of sustainability as being ‘the ability to continue’ it becomes easier”. Nobody wants to be invested in a company that cannot continue to grow and deliver good returns from its operations, aka an unsustainable firm.

The other objection, namely that sustainable investing happens as a trade-off for return, has been widely dismissed. Schroders is confident that they can generate better alpha, or return above the benchmark, by making sustainable investments. As for the lay investor, your best remedy insofar ESG and sustainable investing is to understand what you are buying and to know your manager. The final good news: five years from now you will not have to entertain questions about ESG, impact or sustainability in fund management because it will be the default position.

Writer’s thoughts: The only surprise one should have about the ongoing flow of funds to sustainable investments is that it has taken so long to materialise. I mean it seems a no-brainer that returns earned to the detriment of the environment and / or society are undesirable. Do you agree that impact and sustainability should be part of the DNA of successful modern businesses?