Some interesting papers have been published recently, showing that both High Net Worth and Ultra High Net Worth Individuals (HNWIs and UHNWIs) are increasingly focused on enhancing the sustainability of their portfolios. There are still large intergenerational differences but even the over- 55s expect the portion of their portfolio invested in sustainable solutions to increase in the coming years1. As demand picks up for sustainable investment solutions, limited supply is also regarded as an obstacle to sustainable investment as shown in the figure below. It is therefore not surprising that banks are looking into how they can implement sustainability in their clients’ portfolios.
Figure 1: Key Obstacles to Sustainable Investment (as reported by UHNWIs)2
But what is this type of investing exactly? Responsible investment is an approach to investing that aims to incorporate environmental, social and governance (ESG) factors into investment decisions, to better manage risk and generate sustainable, long-term returns.3 It has a number of synonyms, including socially responsible investing (SRI), ESG investing, while Robeco uses the term Sustainability Investing. There are numerous terms and names, and many different forms of sustainability investing and ways to implement it. So how should you go about assessing what best fits your clients’ needs?
How to assess client sustainability investing goals
The first question people often ask with respect to sustainability investing is, how much alpha does it generate? This may be a very relevant question, but it should not be the first question we address. As is the case with all investments, we need to look first at the clients’ investment goals: why does my client want to invest sustainably? There are three main reasons. First, the client wants to be able to sleep well at night, knowing they are not invested in companies that produce products or display behavior that goes against their ethical beliefs. Secondly the client might have altruistic goals – may want to make a difference, for example, by investing in a microfinance fund. In some cases this may involve a tradeoff between returns and fulfilling these goals. However, investing in companies that provide solutions to global problems, relating to water or energy transition, or that contribute to the Sustainable Development Goals (SDG) seems like a good long term investment strategy. The third and last reason is the expectation that using ESG information to build a portfolio actually enhances your risk/return profile. Either by reducing risk or generating alpha relative to a market portfolio. Discussing these three different objectives might give you a better insight into your client’s goals and help determine the best way to implement sustainability investing into their portfolio.
Figure 2: The client’s perspective: why?
Robeco’s funds and mandates already offer a fair level of commitment to all three of these client needs. Over 90% of funds have an ESG-integrated investment approach, using financially material ESG integration to improve investment decisions. We have found that in 30% of cases in the credits market, an issuer’s fundamental rating is affected by ESG considerations, and for equities, on average, 7% of the valuation of global stocks can be attributed to ESG factors. In terms of performance, we have also found that a portfolio consisting of stocks with a positive ESG valuation adjustment actually outperformed. As a result of this, we are confident that structurally including ESG information in our investment processes helps improve our portfolios’ risk/return profile. We give an example of ESG integration in equities below.
Example of ESG integration in the food sector
Overall, we are rather negative on the food manufacturing sector. Packaged foods are frequently unhealthy, often as a result of the excessive use of cheap ingredients to prop up gross margins. Consumers are becoming increasingly aware of this and are moving away from highly manufactured products. This will have a negative impact on sales growth, which in turn will affect margins as a result of negative operating leverage. Replacing cheap sugar, salt and fat to make products consumer-relevant again will further require margin investments by food manufacturers. We are underweight this sector, but invest in some names with a healthier product portfolio. These are companies at the forefront of restructuring; those with significant R&D capabilities. As a result of this, we assume higher growth rates and margins for the company in the example below, than would have otherwise been the case, due to its better performance in terms of innovation/health and supply chain management.
Figure 3: Case example ESG integration in the food manufacturing sector
Besides ESG integration we also use active ownership (engagement and voting) as a tool to influence corporate behavior and make a difference for our clients. Lastly Robeco has an exclusion policy, more details of which can be found on our website.
For clients that want to go a step further, Robeco and RobecoSAM offer a Sustainability Focus range that includes thematic strategies that take advantage of long term sustainability trends and funds that have wider universe restrictions and explicit environmental footprint reduction parameters.
Are sustainability fund ratings a useful tool?
Fund sustainability ratings can be a useful starting point for an advisor. These ratings often give a snap shot of a fund’s portfolio holdings based on its ESG score. This is a good first step in improving awareness of the topic. However, there are also several disadvantages. Investing means looking forward and these ratings only provide a snapshot of the current situation. If a fund has no clear future sustainability investment policy, then an investor can buy into a portfolio that is highly ranked today, only to discover after a few months or years that its score has completely changed.
So, these methods are merely a starting point and one that is as yet far from perfect. However, there are a number of factors that would really improve these ratings:
- Adjustment for biases in the universe. For example, investing in large cap European stocks would really help your rating right now.
- Don’t take a snapshot, be more forward looking. Take into account the investment process and the engagement efforts of an asset manager too. This analysis is more time consuming and costs more, but is of much higher quality.
- Focus on the financial materiality of scores, but also incorporate a top-down view of sectors and ESG issues. For example, how does a worst-in-class media company compare to a worst-in-class mining company? From both a societal and financial perspective, the impact of the latter is much bigger.
Best practice in sustainable investing by banks
In Europe we see some early adopters of sustainability investing. One bank has rolled out an SRI range to their discretionary portfolio management and advisory clients by offering SRI Mandates, funds of funds and advisory services. The bank’s management is committed to sustainability investing and all new clients are advised to invest in sustainable portfolios. Conventional solutions are only offered to clients who specifically do not want to invest sustainably. A large proportion of the bank’s marketing budget is also allocated to SRI. Its investments are in both ESG-integrated and ESG-focus solutions. Its local manager selection team runs the portfolio construction and fund selection, while a separate dedicated SI team checks all investments from a sustainability perspective. This leading approach has resulted in relatively large inflows for the bank compared to its competitors.
A further example worth mentioning is another bank that has developed fund sustainability ratings as a tool to support portfolio managers and client advisors in integrating sustainability values into investment proposals. The ratings are applied to ‘conventional’ funds too, as the company wants to increase transparency on sustainability aspects for all their products and does not think that sustainable solutions should necessarily just be constructed from pure sustainability funds, but can also contain ESG-integrated funds. In addition to the score each fund also has a sustainability report, which indicates the aforementioned sustainability rating, but also additional sustainability-related information. This data, like portfolio revenue exposure to opportunities, certain business activities (weapons, tobacco etc.) and controversies and its carbon footprint, could be relevant for client considerations regarding values and intended impact. To overcome those issues associated with only carrying out this assessment at portfolio level (as mentioned above), the next step will be for the bank to look into also implementing the ESG integration approach in the fund manager due diligence process.
Robeco’s experience and investor dilemmas
To arrive at the integrated approach that Robeco now applies to its investments has been a journey. A number of elements need to be in place in order to take sustainability seriously.
Support from top management is important and setting appropriate goals for the investment teams and other departments helps this process. However, this is not enough as doing only this might lead to addressing ESG becoming a box-ticking exercise rather than a long-term strategic process. It is therefore important to also provide people with the right tools, in this case relevant research and information. Furthermore, having SI specialists in the investment teams ensures frameworks are developed that they can work with in their own investment processes. These can be supplemented by a clear message house and our investment beliefs. It is important here to differentiate between ethical, integration and impact goals. For example, one of our four key investment beliefs is that using ESG information leads to better informed investment decisions and benefits society.
The dilemma for many investors is that ESG is forward looking and still relatively new. There is as yet limited academic evidence to support its effects nor are there clear financial frameworks and standards and so measuring its impact remains difficult. If the goals are too ambitious (for example, a complete re-orientation of the investment philosophy in one step), little will happen. Taking more gradual steps can help. You can then learn from your experiences as you move forward and ensure you communicate transparently on what you do and don’t do. Your ESG strategy will evolve over time as will your level of expertise and confidence!
1 The Culture Challenge: HNWIs’ Vision for the Wealth Management Industry in the Information Age, Factset
2 Ultra High-Net-Worth Individuals (UHNWIs), Private Banks, and Sustainable Finance Working Paper, August 2017, Ben Caldecott, Elizabeth Harnett, Duncan MacDonald-Korth, University of Oxford Smith School of Enterprise and the Environment
3 Source: United Nations Principles for Responsible Investing
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