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ESG 2.0

7 Jan 2019

Climate change, #MeToo, plastics: ESG in 2019 might sound like a repeat of last year but that is where the similarity ends. Mark Dunne finds out what lies ahead for investors.

ESG was not part of the news in 2018; it was the news.

Environmental, social and governance issues took centre stage on the global news agenda in a way that it had never done before.

Wildfires in California destroyed the homes of Hollywood royalty and claimed the lives of 88 people. The #MeToo movement didn’t peter out, but instead gained in strength and influence in the fight against sexual harassment and sexual assault. Social media platform Facebook lost around a quarter of its value following a series of scandals during the year, one of which was Cambridge Analytica harvesting peoples’ personal data without their consent for political purposes.

Then in December, Sir David Attenborough grabbed the headlines when he warned that climate change is humanity’s greatest threat in thousands of years in that it could lead to the extinction of much of the natural world. Attenborough is prime time. When he speaks the world listens.

So it appears that 2018 was a watershed moment for ESG. It was the year it became mainstream. It is no longer just about longhaired vegetarians protesting outside coalfired power stations.

Those who need convincing should consider this. The climate change-denying Trump administration issued a report putting the fires that swept through California at the feet of rising temperatures caused by greenhouse gas emissions.

There may not be fires in every country, but climate change is a global problem. For Curt Custard, Newton Investment Management’s chief investment officer, no business is immune to the effects of rising temperatures.

“These things are happening and are going to have a material impact on companies, no matter where they are located in the world, whether this be in terms of supply chains, stranded assets or the effect it will have on their customers,” he adds.

“ESG is continuing to grow on everybody’s radar screen,” Custard says, judging by many of the discussions he is having with Newton’s clients, and after examining the results of a recent survey Newton conducted in the US which highlighted strong demand for ESG-focused investment strategies.

NEW YEAR, OLD ISSUES

So what does 2019 have in store?

Fawzy Salarbux, head of consultant relations at Candriam Investors, does not expect to see too many differences this year from the topics that dominated ESG discussions in 2018. “From an asset owner’s point of view, ESG is a long game, it’s a journey, so the themes do not change yearon-year,” he says.

One of those issues is climate change. Carola van Lamoen, who in leading Robeco’s active ownership team is responsible for the asset manager’s engagement and voting activities, expects the topic to dominate the ESG headlines again this year.

“Climate change risk management will continue to rise in the ranks of importance for investors,” Lamoen says. “In line with Task Force on Climate-related Financial Disclosures (TCFD) recommendations, a growing number of investors will take steps toward the measurement of the carbon footprint of their portfolios and define targets to act in line with the Paris climate agreement.”

Measuring the impact and performance of the non-financial aspects of an investment is climbing up the agenda for investors. Indeed, Newton’s survey on individual attitudes towards investing in the US found that they want their ESG criteria to be tangible.

“Most people accept that climate change is happening. Most people accept that companies with greater diversity are better run. The ability to track and measure the steps companies are taking to make it tangible will be critical for asset managers,” Custard says.

This is proving difficult, but managers are working on improving the information they gather. “Currently, financial data is better than ESG data, however the data around measuring ESG factors is improving all the time,” he adds.

The quality and volume of information is a big issue. “Clients are rightfully wary of green-washing,” Custard says.

Investors want to make sure that a product or company is as sustainable as an asset manager claims it is. To avoid such problems Newton doesn’t employ passive analysts, as there is “no place for box tickers” at the firm. It has developed a set of scores that are used to assess companies.

Another person predicting a rise in companies linking certain ESG structures and practices to their financial returns this year is John Streur, president and chief executive of Calvert Research and Management. This stepping away from risk mitigation and towards positive change within corporations in terms of how they deal with these issues to strengthen their competitive position and drive profits is what Streur calls ESG 2.0.

“The headlines that will be the most interesting will be associated with companies that begin to provide an insight into how they are using ESG practices to drive positive financial results,” he adds.

John Belgrove, a senior partner at Aon, also expects to see major developments around the search for more consistent measurement criteria.

Belgrove says that the past few years have seen an increasing and strong clamour for education on this area. “For me there have been a number of game changers – the dominant one has been regulation,” he adds. “Whatever your views, whether you like it or not, this is on your agenda now.” This is a nod to the Department for Work and Pensions (DWP) making trustees
explain how they are dealing with climate change in their portfolio from October. “That should create news-flow,” Belgrove says.

DIVERSITY

Custard does not expect #MeToo’s influence to fade in the coming 12 months. “These kinds of movements do not peter out after a year,” Custard says. “The focus on gender diversity is going to continue to matter.”

But he adds that it is not just about getting more women into boardrooms; there is a need for broader diversity. “Gender is a relatively narrow lens,” he adds. “You want to have cognitive diversity. You want people to think differently and offer different perspectives to help solve problems and come up with the most robust solution.”

So the ‘S’ in ESG is going to grow in importance from this year with investors taking action to create a more inclusive economic system, whether it be gender, race or income.

“There is a recognition by global leaders – government officials, investors, CEOs – that the level of inequality that capitalism has created is potentially de-stabilising to the system and must be addressed,” Streur says.

“Inequality manifests itself in many ways,” he adds. “That is a bigger potential [headline] grabber than climate change because climate change is pretty well known.

“If we allow inequality to advance as it has been, the entire system will suffer and the pie will not grow as much as it should,” Streur says. “If we can address inequality and create a more inclusive economic system then the pie will grow at a better rate.” This is a topic that Streur is passionate about, pointing out that he believes addressing inequality is going to be “front and centre” in 2019. “The #MeToo movement is a symptom of an unhealthy system.

“There are other risks to the system that are just as big or even bigger as a result of all the various forms of inequality,” he adds. “The #MeToo movement has been effective in helping boards to understand the risks they face as a result of inequality within corporations.”

GOVERNANCE

High governance standards are rarely absent from the wish-lists of ESG-focused and conventional investors. Yet could forecasts of low investment returns and increasing volatility make ESG-led strategies more prominent this year?

“As we start to see interest rates tighten around the world, the ability for badly managed companies to hide just how badly they have been managed is going to disappear,” Custard says. “How well a company is run in terms of the transparency and rigour of its governance is going to continue to come to the fore.”

What could change is that more investors start incorporating ESG factors into their decisions as market conditions change.

“It is widely agreed that we are about to hit a period of sustained low returns but accompanied by higher risk and volatility than has been the case in the past decade or so,” Salarbux says. “Therefore it is hard to capture those meagre returns most efficiently. That sits very well with investing in a responsible and sustainable way. It is an approach that helps to manage risk on a number of levels.

“Its value to investors will become more apparent as financial results come through in what could be relatively leaner times in the next few years,” he adds.

SUSTAINABLE DEBT

The green bond market has been growing for several years as companies and government agencies seek to fund climate-friendly projects. Yet unfortunately it remains a niche market due to issuers limited to a small group of sectors, especially infrastructure.

But this year could see an increase in those looking to raise capital to fund ESG-related projects from another asset class, David Czupryna, Candriam’s senior SRI client portfolio manager, believes.

There is an alternative to green bonds that could open the fixed income market up to a broader range of issuers and investors. Sustainable bonds are similar to their green counterparts but have broader aims. It is not just about clean energy plants; they could be used to finance social projects. They could also give investors more say in how the funding is used.

“Issuers are coming up with new ways to tap growing demand for sustainable products,” Czupryna says. “Fixed income has been lagging in that you do not have a seat at the table in the same way that you do when you buy equity. Lenders are not treated in the same way.

“So these sustainable bonds are a new trend,” he adds. “We think that this is the next frontier in sustainable investing in fixed income and is going to be a major topic.”

PLASTIC NOT SO FANTASTIC

Regulation and popular interest will keep plastics on the agenda when investors meet with their portfolio companies this year.

Images of plastic bottles and bags floating in the ocean have featured in documentaries, campaigns and mainstream news stories over concerns of the impact that such pollution is having on marine life.

“We expect to see more work with the Plastic Solutions Investor Alliance (PSIA) and other collaborative initiatives,” Robeco’s Lamoen says. “This will impact the food and beverages sector and plastic packaging producers.”

Plastic, climate change, diversity and new ways of raising capital for sustainable projects could be lying in wait for us in the year ahead. Yet one thing appears to be certain: ESG issues will not just appear in the news in 2019; it will continue to be the news.

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