Investing clients’ cash for good
Global asset managers have to go beyond filling their investment portfolios with green companies to ‘walk the talk’ by considering sustainability in every aspect of their operations. “We are well-rehearsed at incorporating sustainability into our investing activities,” says Kondi Nkosi, Country Head: South Africa at Schroders. “[Our current focus] is on walking the talk as we make headway on our journey towards being a carbon neutral organisation”. The asset manager is among those that have signed the Net Zero Asset Manager initiative as part of a global drive to transition to a lower carbon world. Nkosi was commenting during a Schroders’ presentation titled How sustainability will be fundamental to progress.
Incorporating sustainability into investment decisions
Hannah Simons, Head of Sustainability Strategy at the asset manager, said that Schroders’ sustainable investing journey had been more than 20 years in the making. “We recently achieved full environment, social and governance (ESG) integration, meaning that every one of our 50 investment desks are incorporating sustainability considerations into their investment decision making process; we have guidelines on how to deal with companies that show material sustainability risks”. Simons discussed the evolution of the asset management industry over the past two decades.
The entire asset management industry used to be narrowly focused on delivering maximum return. Asset managers viewed their portfolios and portfolio outcomes against the absolute measure of return, with little consideration for how individual companies chipped in to the overall portfolio return. Over time the industry expanded its measurement criteria to incorporate risk alongside return. “The development of risk models and quantitative investment processes allowed for a shift from a return-only model to one that consider both risk and return; but both risk and return are backward-looking measures that tell us about what happened to investments in the past,” said Simons.
Addressing the risk and return obsessions
The best way to address the backward-looking shortcoming of the industry’s risk and return obsession was to throw a third dimension into the investing decision making process, namely impact. Simons said that in order to fully understand risk and return the industry had to consider the potential impact of its investing activities. In other words, they must consider the impact that each of the underlying companies in a portfolio has on the environment and society. It helps to think of this impact from a sustainability point of view. The management of sustainability risk is now firmly in the spotlight of global market regulators with the introduction of sustainability finance regulations in Europe. Industry stakeholders are also doing their part, as evidenced by the emerging trend towards ESG and impact investing, driven by asset managers and investors.
Financial advisers and their clients, the ultimate beneficiaries of sustainable investing activities, are putting pressure on the industry to drive change. “We have identified that clients see sustainability as something they want to embed in their investment processes,” said Simonds. The demands from asset managers, investors and regulators are finally being taken on board by companies who realise that sustainability is a key component for their future success. They face a new world where investment capital, whether in the form of a bank-sourced financial instrument or asset manager backing, comes with plenty of ‘green’ strings attached. Analysts say that there will be huge opportunities for the sustainable application of investment capital as the world strives to achieve the United Nations (UN) Sustainable Development Goals (SDGs). At current rates of investment the world faces a US$5-7 trillion per annum sustainable development funding gap over the next decade.
Accurate impact measurement is challenging
One of the challenges facing 21st Century asset managers is how to measure the impact that their investing activities delivers. Schroders has taken a decision to develop proprietary measurement methodologies due to various inconsistencies in third party sustainability information. They observe that the various sustainability indices offer inconsistent views and low correlations, with an added detraction being their historic focus. “Even the third parties cannot agree on what constitutes a good company from a sustainable investing perspective,” said Simonds. Schroders uses a stakeholder-focused model that considers impact through six lenses, namely employees, community, customers, regulators, environment and suppliers.
Financial advisers and their clients will benefit from the insights generated by the asset manager’s SustainEx tool, which ranks companies by considering the estimated financial cost of unsustainable activities. An investment decision can now be taken forearmed with information about potential liabilities that do not appear on a company’s balance sheet and that arise from the ongoing social costs that a company incurs through its operations. Such costs include the cost of carbon emissions, the social cost of alcohol and tobacco sales, the failure to remunerate staff at acceptable levels etc. “We look at over 36 factors to identify elements that carry social cost and benefit,” said Simonds. This data is consolidated as a social index score for more than 16000 global firms.
Getting companies to ‘walk the talk’
Another important tool, ThemeEx, allows the asset manager’s investment teams to map companies’ contributions to sustainability based on the impacts of their products and services. “The critical thing about a proprietary tool is that it allows us to understand and manipulate the data to get behind what a company is actually doing,” concluded Simonds. “We assess each company’s exposure to the UN SDGs and then carry that through at portfolio level before sharing this view with clients and investors”.
Writer’s thoughts:
One of the concerns raised during Schroders’ presentation was that an overreliance on ESG and impact investing criteria could negatively impact critical industries in developing economies. What happens, for example, if a country like South Africa, heavily dependent on fossil fuels for electricity production, can no longer source funding for its coal supply chain? Such big picture concerns are probably beyond the remit of your individual clients. Today we ask: Are your clients asking you questions about how green or sustainable their investment portfolios are? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
