Responsible investment gathers pace globally, driven by socially minded investors who understand its impact on financial returns

By Miranda Barham & Kim Croucher from the WAM UK Steering Committee with critical contribution from Martina Macpherson & Natacha Dimitrijevic

Back in April, WAM UK welcomed Natacha Dimitrijevic, an Associate Director at Hermes Equity Ownership Services and Martina Macpherson, Head of Sustainability Indices at S&P Dow Jones Indices (formerly Managing Partner of SI Partners) to talk about responsible investment. Sustainability is relevant to all of us as consumers, but also to those of us who are pension fund holders and investors. Natacha and Martina were there to tell us why companies that are encouraged to be more sustainable are more likely to yield a good return to equity owners – and how investors, no matter how small, can and should utilise their voice to positively influence their active and passive investments.

The state of the sustainable investment market

The size of global sustainable investment assets have expanded dramatically in recent years, rising from $13.3trillion in 2012 to reach a total of $21.4trillion at the start of 2014 according to a Report by GSIA (2014)[1]. The establishment of the UN-backed Principles for Responsible Investment (PRI) in 2006 has been instrumental in raising awareness about responsible and sustainable investment among the global investment community, increasing the level of transparency around the activities and capabilities of its signatories and fostering collaboration between them, and supporting their engagements with companies and policymakers on environmental, social and governance (ESG) issues. Nowadays, the six voluntary Principles for Responsible Investment have nearly 1,500 signatories, from over 50 countries, representing $60 trillion.[2]But is sustainable investing of growing interest in all parts of the world? According to GSIA’s Report, sustainable and responsible investment strategies around the world have grown significantly, for example, in Europe they have grown at an even faster rate than the broad European asset management market. In the United States, socially responsible investment (SRI) assets were $6.57 trillion in 2014—a 76-percent increase over the $3.74 trillion identified in sustainable investing strategies at the outset of 2012. In Australia and New Zealand, sustainable investing assets managed by asset managers, super funds, banks and advisers in 2014 reached $180 billion. Sustainable investment assets in Asia, although still comprising only a small share of total professionally managed assets in the region, reached $53 billion in 2014, an increase of 32 percent from the $40 billion tallied at the start of 2012.

Doing well by doing good?

During the evening, our discussion touched on the big question of whether companies should be acting in better ways just for social good as opposed to purely operating for financial profit.

We discussed the concept of getting companies to think about how they deal with risk and return for all stakeholders such as suppliers, and the communities in which they operate and not just their shareholders.

Some guests admitted their frustration in persuading some organisations to take into account a broader range of stakeholders when making decisions or to address social concerns they advocate on as members of civil society.

It was interesting to see these same guests come to see the leverage that equity investors can have on companies, with their vote in how the company is run. By the end of the evening, opinions seemed to remain divided on how best to tackle these issues, but it was recognised that the social good element was signficantly helped by socially minded investors driving the agenda.

But the point is that investors in the RI space are socially minded, because they believe socially beneficial behaviour has an influence on long-term financial returns.

Incorporating stewardship considerations into investment decision-making

There is also an ethical dimension to taking the stewardship responsibility of active ownership seriously. According to the ILO, the 200 largest MNEs (of the approximately 50,000 MNEs) worldwide have sales equivalent to almost 30% of the world’s GDP and approximately 80% of global trade activities are within the global value chain of MNEs[3] – the subsidiaries and extended value chains of MNEs represent an important share of the private sector in many developing and industrialised economies.

MNEs are impacting communities through job creation, investment, environmental footprint, as purchasers and consumers and more. In short, the impact of MNEs on the world is incredibly substantial – and not just in terms of economics and development, but in terms of the environment and use of natural resources. It can only be deduced that influencing MNEs, even in a small way – can have a huge impact on the communities in which we live.

Martina kicked-off the evening by presenting the current state of sustainable investing across sectors and asset classes and she outlined the key reasons why companies decide to tackle sustainability issues. Top of the list still stands customer demand, with more than 65% of companies[4] polled by oekom research’s Impact Study (2013) admitting that customers’ views was a factor in their decision-making to tackle sustainability issues. However, pressure from rating agencies and from sustainability-oriented investors came a close second and third in the poll’s rankings – demonstrating that the sustainable investment movement overall is a key driver in this area. Surprisingly reputational concerns came further down the list, where only 22% of companies polled said the company’s reputation was a factor on why sustainability matters.

Martina outlined that the largest sustainable investment approach globally by AUM remains negative screening/exclusions ($14.4 trillion), which is effectively the action by sustainable active or passive investors to exclude certain companies from their investment portfolios if they don’t meet a range of pre-defined sustainability criteria and metrics.^[5]We learnt that this is a highly effective means to focus the attention of companies towards better sustainability performance and practices.

Boards and management will pay attention if pension funds and asset managers publicly state that they will screen out certain unsustainable practices or risk factors from their portfolios. However, this is a ‘tradtional’method of influence and, for example, doesn’t tackle those companies that act in industries that would naturally be excluded from a sustainability funding anyway – such as fossil fuel energy.

The investment case for active ownership

It was put forward on the night that there is a more effective way to tackle the behaviour of companies in certain unfavoured sectors through a more active form of corporate engagement and direct shareholder action[6].

These activities are evolving and gaining ground ($7.0 trillion under management according to the GSIA Report) and allow investors to take an active role in shaping a company’s response to sustainability issues. It is though a more intensive and expensive approach – but one which many think will pay off in the long-run.

Hermes Equity Ownership Services (EOS) is exactly situated in this space. Natacha spoke on the night of the work she does to engage regularly with boards that her pension fund clients are invested in – highlighting to the board practices the companies partake in, which may not provide a sustainable base for long-term growth (for example relating to corporate governance, labour conditions, environmental impact and more) – and it is this long-term growth or continued existence that pension fund investors are most interested in protecting. Sometimes these may be issues that management have not fully appreciated or looked at – but sometimes she may try to address the more contentious issues. Either way, the experience of Hermes EOS is that boards and companies will engage – particularly since Hermes EOS is typically speaking on behalf of clients with billions of dollars invested in the company.

Financial institutions around the world are increasingly required to demonstrate responsible behaviour. Good stewardship of assets is a critical component of what it means to be a responsible investor. Engaging with companies and policy-makers on environmental, social, governance, strategic and risk issues where relevant is now widely recognized as adding long-term value to the investments and core to managing risks.

Sustainable investment innovation – the journey continues

Sustainable investing is also benefiting from developing technology, frameworks and innovation. Quantitative ESG research metrics, (real time) data analytics solutions and financial instruments such as indices, have hence become increasingly available for investors. As a result, ESG integration across asset classes, and across active and passive investing, has become a widely-used investment practice. And research into the relationship between financial performance and ESG factors, both academic and applied, has improved in quantity and quality.

On the corporate side, ESG disclosure and reporting have moved from ‘nice to have’ to ‘must have,’ as regulatory developments have accelerated worldwide. According to data analytics house eRevalue, 180 sustainability-related regulations were identified in 2013. Nowadays, there are already over 1,300.[7] This fast-paced transition from a normative to a compliance ESG regulatory framework presents increased reputational and commercial risks for businesses.

Ultimately, ESG integration is and remains a major ‘trend’. ESG integration is happening across the investment industry, across mainstream capital markets and across the ‘world of big data analytics’. ESG integration into credit and fund ratings is one of these trends, new developments of passive, active ownership as well as corporate and investor dialogue based on more aligned ESG factors and ‘harmonised’ definitions and approaches of materiality  is another.

However, we need to be careful to avoid ‘green washing’ or ‘sustainability washing’ tactics to prevent a ‘green bubble’. Commitment (and purpose), due diligence, disclosure and dialogue remain key fundamentals for this industry.

[1] Source: GSIA, Global Sustainable Investment Review, 2014: http://www.gsi-alliance.org/wp-content/uploads/2015/02/GSIA_Review_download.pdf

[2] Source: PRI, About UNPRI, 2016: https://www.unpri.org/about

[3] Source: Engaging multinational enterprises on more and better jobs, ILO Factsheet, 3 November 2014: http://www.ilo.ch/wcmsp5/groups/public/—ed_emp/—emp_ent/—multi/documents/publication/wcms_175477.pdf

[4] Source: oekom research, The Impact of SRI, May 2013: http://www.oekom-research.com/homepage/english/oekom_Impact-Study_EN.pdf

[5] Source: Martina Macpherson, The Growing Impact of Sustainability, in S&P Dow Jones Indices ‘Indexology’ Magazine, October 2016: http://html5.epaperflip.com/?docid=a4a2e679-c941-483f-993e-a69e012007d2&utm_medium=Email&utm_source=Eloqua#page=1

[6] See also Arabesque, From the Stockholder to the Stakeholder, March 2015: http://www.arabesque.com/index.php?tt_down=51e2de00a30f88872897824d3e211b11

[7] Source: eRevalue, Sustainability Regulations and Trends, March 2016: http://www.erevalue.com/

 

The State of Responsible Investment

by WAM UK

For our dinner event on responsible investment, specifically looking at how we can influence the way global companies act and impact the world, we interviewed one of the speakers, Martina Macpherson, Managing Partner of SI Partners.  

On the evening Martina Macpherson will be accompanied by Natacha Dimitrijevic, Associate Director at Hermes Equity Ownership Services and together they will lead an interactive discussion on responsible investment and the role of stakeholders in the investment value chain.

In theory long-term shareholder interests are aligned with environmental and social good. How does this work?

Large institutional investors, most of them pension funds are, in effect, ‘Universal Owners’, as they often have highly-diversified and long-term portfolios that are representative of global capital markets. Their portfolios are inevitably exposed to the external costs of business. Corruption, for instance, could lead to a significant fine with a direct impact on a company performance, but it also raises the cost of doing business for all others. Unchecked carbon emissions raises questions on a company’s quality of management; it also contributes to climate change with increased financial risks for all.  Long-term economic value creation and the wellbeing of beneficiaries are at stake.  Hence, long-term investors can and should act collectively to reduce financial risk from environmental and social impacts which means they have a responsibility to adopt an investment approach which considers sustainability issues.

Some investors have started to utilise a proxy such as employee safety. If we look at BP, this is a prime example where the safety record could have signalled future risk. Imperfect safety procedures in its US operations led to accidents and eventually the Gulf of Mexico oil spill that cost the firm tens of billions. Another more recent example is BHP Billiton, where shares hit a seven-year low after the Brazil dam disaster in November 2015.

How sensitive are companies (board and management) these days to sustainability issues in their business – how has this changed over the last 10 years?

Over the past decade, companies have started to think more intentionally about how to maximize shareholder value by exploring the complex interplay between financial, human, social…. Investments in better training, healthcare for instance have demonstrated direct financial returns through gains in productivity and efficiency.  Support for social programmes has accelerated economic growth and raised incomes – creating a wider consumer base and easing entry into new markets.

Terms like ‘shared value’ and ‘triple bottom-line’ are now commonplace in board rooms around the globe. As a result, corporate social responsibility (CSR) is no longer conceived as a series of seemingly random feel-good grants, but as an essential tool that impacts a company’s philosophy and core business strategy including its brand value, market access and operations.

This development is also supported by global norms and social initiatives such as the Sustainable Development Goals, more defined reporting and accounting frameworks such as GRI, IIRC, SASB or UNGP and encouraged by legislation, such as the EU Directive 2014/95/EU of non-financial and diversity information and the Modern Slavery Act, UK.

 While it sounds like an ideal situation if all investors took a long-term approach to investing, it would seem that many still chase short term returns and gains.  What proportion of global investment really now takes into account ESG issues?

The global sustainable investment market has grown both in absolute and relative terms to US$21.4 trillion at the start of 2014 – equal to approximately 25% of all the world’s financial holdings.

Source: GSIA, ‘Global Sustainable Investment Review 2014’

Negative screening, integration of  environmental, social and corporate governance (ESG) factors into investment processes and corporate engagement have been identified as the key investment approaches (for market growth and ‘impact’), in Europe and across the globe:

Source: Eurosif, European SRI Study, 2014

Overall, the definition of best practices in ESG integration is evolving very quickly. A few years ago, being a PRI signatory – where signatories pledge their support for responsible investment and incorporate ESG factors into their approach – was considered as advanced; it is now seen as a requirement for asset managers and, instead, the focus has shifted to measuring and benchmarking the effectiveness of ESG factors.

This blog also appears on Business Fights Poverty