Welcome to this exciting special issue of Citywire Asia, which examines all things ESG. In the following pages, we delve into the ESG trends gaining traction not only in Singapore and Hong Kong but also in Thailand, India and China. Top fund selectors share their thoughts about what’s working in their markets and reveal the type of products they hope to introduce to clients this year to meet specific objectives. Jacky Tang from Goldman Sachs Private Wealth Management says some investors may not consider a food processing company to be ESG-aligned but others may see potential there. A key differentiator for Asian and emerging markets are investment solutions that are focused on regional characteristics relevant to the investments, rather than ones based simply on a process that identifies opportunities and risks, according to Bank of Singapore’s Jean Chia. Elsewhere, Thai clients are demanding more innovative solutions, Edwin Tan from Credit Suisse says, while in India, Citi Private Bank is seeing a promising start as multiple ESG-focused mutual funds launch, according to Puneet Sanwalka. Across two in-depth interviews, Credit Suisse’s Joost Bilkes discusses the difference between sustainable and impactful investing, while Fan Cheuk Wan from HSBC Private Banking says alternative investments are increasingly adopting ESG principles. We also reveal some of the top ESG fund managers in Asia, brought to you by exclusive Citywire data. I hope you find this special issue illuminating and inspiring. Enjoy!
Editor's note
Exchange Traded Funds can unlock sustainable investing in Asia-Pacific: BlackRock
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CONTENTs
audrey raj
editor, citywire asia
©citywire financial publishers PHOTO creditS: getty images, unsplash, alamy
The big question: Where next for ESG?
Chapter one
ESG and impact investing
chapter two
Why responsible investing has greater potential in emerging markets
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Investing in times of a changing climate
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ESG that makes a difference
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ESG and alternatives
chapter three
Pricing ESG risk in credit markets: through volatility, our conviction confirmed
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Asia’s top-rated ESG managers
chapter four
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Disclaimer This material is prepared by BlackRock and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of March 2021 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. In Hong Kong, this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. In Singapore, this material is issued by BlackRock (Singapore) Limited (company registration number: 200010143N). This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. The information provided here is not intended to constitute financial, tax, legal or accounting advice. You should consult your own advisers on such matters. BlackRock does not guarantee the suitability or potential value of any particular investment. Investment involves risk including possible loss of principal. Past performance is not an indication for the future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments to fluctuate. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. ©2021 BlackRock, Inc. All Rights Reserved. BlackRock® is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners. MKTGM0421A/S-1601513
1. Source: Sumathi Bala, 2021, "ESG investments surged in Asia-Pacific in 2020 as sustainable investing takes off, MSCI survey finds", CNBC, 4 March 2021
The strong performance of environmental, social and governance (ESG)-related investment products during 2020 and the need to address climate change through investment, will underpin broader ESG uptake across the Asia-Pacific (APAC) region this year and beyond, according to two senior executives at BlackRock. ESG adoption is growing across various investor segments in APAC, going by the evidence of 2020. A recent survey showed that 79% of institutional investors in the region “significantly” or “moderately” accelerated their ESG investments over the course of the year, compared to 77% worldwide. [1] BlackRock is itself committed to expanding its sustainable investing offering, with its research showing that worldwide, asset managers are “overwhelmingly” increasing their exposure to sustainable funds. [2] For many investors, interest in sustainable investing is fueled by performance. During 2020, 81% of a globally representative selection of sustainable indexes outperformed their parent benchmarks, as BlackRock Chairman and CEO Larry Fink recently noted in a letter to corporate leaders. [3] “The performance of ESG assets in downward-trending markets versus non-ESG assets has effectively addressed the concern often voiced by wealth managers, which is, ‘ESG is great, but are my clients going to lose money by investing in it?’", said Anthony Arthur, Head of iShares Asia ex-Japan Wealth Distribution, BlackRock. "I think once that misconception was dispelled, it’s driven a lot of private banking firms to put together their own offering, whether that’s something they offer directly in discretionary portfolio management or by adding third-party products onto their approved list." ESG in Asia still in infancy Interest in APAC was growing even before 2020, with the wealth segment, particularly in private banks, starting to market ESG strategies over the last few years. However, it remains only a small part of the total. “Many countries in Asia are catching up on disclosures, taxonomy and regulation but the region’s approach to sustainable and climate investing will remain heterogeneous compared to monolithic regions like Europe, where there's more standardization. They are a bit more ahead of the curve on this,” said Sunita Subramoniam, APAC Head of Sustainable for ETFs and Index Investments at BlackRock. Subramoniam cautioned that the performance argument for ESG is both a strength and a weakness because there are drivers behind that performance which may or may not sustain in every single diverse APAC market. She also identified the need for more investor education on sustainable investing being a key challenge, with some investors in APAC confused about the differences between different ESG investment strategies. “We’ve done a lot of work around educating investors on what sustainable investing is and how investors can use ESG ETFs in their portfolios through 1 on 1 conversations, as well as customised ETF education programs. We are also transparent about the ESG and carbon metrics for all our products, ESG or otherwise,” she said.
Industry experts from BlackRock see huge potential for ESG in the region, if supported by the necessary expertise.
‘We’ve done a lot of work around educating investors on what sustainable investing is… we are also transparent about the ESG and carbon metrics for all our products’
Arthur added that a thematic approach may attract advisory clients initially in APAC. “It’s easier in some ways to adopt ESG on a thematic basis. These are topical themes that resonate with clients. For example, the clean energy performance over the second half of 2020, linked to the election of Joe Biden as US president. [4] Or renewables [5] and electric vehicles [6], are areas where clients can have conviction...” Taking the ETF route to Sustainable investing Reflecting on what has worked in other markets, BlackRock’s experts argued that Exchange Traded Funds (ETFs) hold the key to unlocking wider-scale sustainable investment across the region. “In Europe and the US, many large investors come in and say, ‘I really believe in this approach, I’m going to launch it as an ETF so I can democratise access onwards for the benefit of other investors.’” Subramoniam noted. ESG ETFs have been used as asset allocation building blocks for distributors creating their own ESG strategies. A number of private banks in Asia have reported raising significant assets in sustainable assets, which feeds further demand across the wealth space. iShares by BlackRock offers over 130 sustainable ETFs that can help investors access sustainable businesses across various developed and emerging markets in equities and fixed income. These ETFs run the gamut from simple exclusionary portfolios screening out weapons, thermal coal and other business areas, to concentrated portfolios of only companies with the highest ESG scores. Alongside, those are also thematic approaches playing into E, S and G opportunities like electric vehicles or clean energy or diversity & inclusion, and even areas of impact investing like green bonds. With countries like China, South Korea, Japan [7] and New Zealand [8] recently announcing net zero ambitions, the relevance of climate considerations in business and in investing cannot be overstated. Arthur sees China as key to the growth of ESG in Asia, provided the right expertise is applied, and predicts that business transformations in China will turn into investment opportunities, not just for Chinese investors but global investors as well. And companies such as BlackRock are taking action in order to be prepared.
‘We are investing in key resources so we can assist our clients by being there as a partner who helps them not only with products but also by… educating their frontline staff...’
“We are investing in key resources so we can assist our clients by being there as a partner who helps them not only with products but also by supporting them in a number of ways, including educating their frontline staff so they can in turn educate their customers,” Arthur said. “Because wealth managers don’t all have the capability to build-out specialised knowledge in this space at this stage of adoption and that’s something we can help with.” “In the post-pandemic world, one thing is clear – ESG risk is financial risk. Exclusions, best-in-class, thematics, impact – these approaches may differ but the trend is secular” added Subramoniam. “The world around us is moving towards a more sustainable future, so shouldn’t our portfolios evolve too?” Sustainable investing with ETFs Exchange Traded Funds (ETF) could be a convenient way for investors to gain exposure to sustainable investing. The simple building block nature of an ETF allows investors to effectively diversify their existing portfolios by adding specific market and/or industry exposures. Other benefits of ETFs include: • • • •
Transparency: ETFs are relatively straightforward and transparent in their investment objective, as well as mostly transparent in their holdings Accessibility: ETFs offer access to market exposure of a variety of asset classes, both broad and specific Liquidity: ETFs tend to be highly liquid, and can be bought and sold during the trading day Cost efficiency: ETFs generally have a lower management fee compared with an active fund invested in the same market and/or assets
2. Source: “Net zero: a fiduciary approach”, BlackRock, 2021
3. Source: “Larry Fink's 2021 letter to CEOs”, BlackRock, 2021
4. Source: “Clean energy investors are betting on Biden”, ENERGYMONITOR, 26 January 2021
5. Source: “Just How Good An Investment Is Renewable Energy? New Study Reveals All”, Forbes, 28 May 2020
6. Source: “Electric vehicles overview”, International Renewable Energy Agency (IRENA), 2021
7. Source: “China, Japan, and Korea promised carbon neutrality. Now we need them to make it happen”, Greenpeace, 26 November 2020
8. Source: “Climate Change Response (Zero Carbon) Amendment Act”, Ministry for the Environment, New Zealand, 25 November 2019
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Sunita Subramoniam, APAC Head of Sustainable for ETFs and Index Investments at BlackRock
Anthony Arthur, Head of iShares Asia ex-Japan Wealth Distribution, BlackRock
For more information on sustainable investing, as well as why climate change will impact investors and how ETFs can help build climate-ready portfolios, read BlackRock’s latest ‘A sea change in global investing’ whitepaper.
What ESG trends have you identified in Hong Kong and what product innovations would you like to see in ESG? Covid-19 has accelerated the ESG trend, with investors rewarding companies that respond to the pandemic by focusing on sustainability rather than near-term profits. In Hong Kong, there have been recent moves to enhance awareness and adoption of sustainable investing. The government has proposed doubling the borrowing ceiling of its green bond program to allow for more issuance, and there has also been a recommendation to encourage public funds to adopt ESG principles. We’ve seen increased interest from clients to incorporate ESG considerations into what we call defined objective portfolios, which are tailored to meet specific objectives. As more ESG products are rolled out in Hong Kong and mainland China, one key area to consider in future product innovation is how to incorporate different ESG metrics. For example, some investors may not consider a food processing company ESG-aligned but others may think otherwise. Coming up with solutions that can cater to different ESG considerations will be an important area to look at in the future.
Jacky Tang Head of portfolio management and portfolio advisory group, Asia, Goldman Sachs Private Wealth Management Location: Hong Kong
‘Some investors may not consider a food processing company ESG-aligned... catering to different ESG considerations will be an important area to look at in the future’
Jacky Tang
What ESG trends have you identified in Singapore and what product innovations would you like to see in ESG? While sustainable investments have been around for decades, we are witnessing a growing consensus around the world that climate change, social and governance factors have important implications for businesses and investments that can no longer be ignored. Singapore is no exception, as we have seen specific focus on climate change and environmental risks. In the Singapore Budget 2021, the government took active steps to encourage the use of electric vehicles through a mix of tax incentives for new electric vehicles and higher petrol duties for internal combustion engines. Just last month, a new initiative called the Singapore Green Plan 2030 was announced as a national sustainability movement to rally bold and collective action across different industries and sectors to tackle climate change. These efforts to ‘green the economy’ will impact every sector. While not unique to Singapore, another important trend is the increasing demand from wealth management clients in the region. We have seen an increase in ESG interest over the past year but the demand for sustainable solutions is likely to intensify as we navigate the largest inter-generational wealth transfer in history. In Asia alone, a total of $930bn is expected to change hands over the next 10 years. Born into a globalised world where there is increasing awareness and information on environmental and social issues, the next generation of private wealth clients are more ESG-focused than their predecessors. Our sustainable research report, published in partnership with EY, also revealed that 95% of millennial investors are interested in sustainable portfolios.
Jean Chia
‘Born into a globalised world where there is increasing awareness and information on environmental and social issues, the next generation of private wealth clients are more ESG-focused than their predecessors’
However, much of the investment solutions and available ESG research and data are still more biased towards the global experience and may not be customized to the Asian context. This is particularly important as the path towards carbon neutrality ― while sustaining economic development and eradicating poverty in the region ― is likely to be different from the rest of the world. A key differentiator for Asian and emerging markets are investment solutions which are focused on the substance of ESG factors and regional characteristics applicable to the investments, rather than one based simply on the form of ESG process to identify unique opportunities and risks. As such, in our research and investment process for equities and fixed income, as well as in the selection of appropriate third-party ESG funds for our clients, we pay particular attention to understanding how managers are internalizing the ESG impact on its portfolios and aligning these with investment objectives.
Jean Chia Head of portfolio management and research office, Bank of Singapore Location: Singapore
Edwin Tan Head of wealth management onshoreand head of investment & advisory solutions, Thailand, Credit Suisse Location: Thailand
What ESG trends have you identified in Thailand and what product innovations would you like to see in ESG? One of our strategic ambitions is to position Credit Suisse as a sustainability leader. Our sustainable assets under management (AUM) in private banking across the Asia Pacific region experienced robust growth in the last two years, showcasing that sustainability is not only becoming increasingly important to our clients, but that ESG-related products and solutions have become an integral part of our offering. We are convinced that the integration of ESG criteria into our investment strategies will create durable performance benefits, positioning us to generate attractive investment returns over the long term. We are seeing tremendous interest from clients for a wide variety of sustainable solutions and they are also demanding more innovative solutions in this space. Their investment appetite is getting more sophisticated and now goes beyond traditional exclusionary strategies from the investment universe.
‘We have launched an innovative venture capital strategy with very tangible ESG themes that backs disruptive technologies aiming to reduce carbon emissions and in turn limit climate change’
In recent years, our clients have allocated more capital towards sustainable thematic and impact investing strategies which focus on mobilizing capital for activities that address sustainable development goals (SDGs) and generate positive, measurable social and environmental impact alongside a financial return. In fact, AUM generated from these strategies grew strongly. We have an extensive suite of sustainable solutions across all asset classes and we are continuously working towards further deepening our sustainability-related offerings, to serve the multifaceted needs of our clients in this space. For example this year, we have also launched an innovative venture capital strategy with very tangible ESG themes that backs disruptive technologies aiming to reduce carbon emissions and in turn limit climate change.
Edwin Tan
Caroline Cheng Executive director, Bank J. Safra Sarasin Location: Hong Kong
What ESG trends have you identified in China and what product innovations would you like to see in ESG? The pandemic experience has made ESG consideration more relevant for investors in their investment decisions. ESG investments attracted a lot of capital last year, partly driven by the wider integration of ESG criteria in investment selection by global investment professionals. As the ESG criteria become an integral part to investment analyses, demand for sustainable investments will grow from here. Moreover, global governments’ collaboration to engage in green initiatives have opened up new investment opportunities. Imagine a smart city having sustainable buildings using eco-friendly materials for refurbishment and decoration, renewable energies for power and electric vehicles for your commute. That will need government policies to support the transition and technological innovations to facilitate the transformation. In Asia, major economies, such as China and Japan, pledge to be carbon neutral in 2060 and 2050, respectively, and this will be instrumental to shaping products and services developments as well as consumption patterns going forward.
We have seen more fund strategies dedicating to sustainable investing in the past 12 to 24 months. Some of them are broad-based, multi-sector strategies and some focus on single themes. In a nutshell, the concept is getting more immersed in everyday life. Digital consumption and electric vehicles were the hot themes last year and are still brewing. Beside a policy push for sustainable infrastructure and renewable energies, other basics of living such as sustainable buildings or green food and packaging would play a part to complete a smart city or country. Having been a sustainability advocate for over 30 years, we are glad to see these ideas flourishing. We are convinced that these initiatives are not short-term quick fixes and sustainability as an investment trend has only started to gain serious, extensive attention. Nonetheless, we try not to be overly excited by this evolving trend, but keep a vigilant eye on valuations. On top of the contribution to preserving the ecosystem, we will continue to prioritize quality of investments; preferably, these companies can realize profits from their innovative green solutions and lower financial costs by improving resource efficiency. After all, any investments that can benefit from government policies, tap a growing market, attract capital investment and reduce social and financial costs should fall under any investors’ radar.
Caroline Cheng
‘Beside a policy push for sustainable infrastructure and renewable energies, other basics of living such as sustainable buildings or green food and packaging would play a part to complete a smart city or country’
Puneet Sanwalka Head of onshore private banking, Citi Private Bank Location: India
What ESG trends have you identified in India and what product innovations would you like to see in ESG? ESG Investing is gaining traction in India as the regulatory framework and government policies increasingly build emphasis on corporate governance, sustainability and climate change. The SEBI Stewardship Code that is proposed to be implemented from 1 July, will be a significant step in the way institutional investors exercise their voting rights in favour of better governance practices. One of our aims at Citi is to work with the asset management industry to make more ESG-focused investment options available to our clients. We have seen a promising start as multiple ESG focused mutual funds and AIFs have been launched and AMC companies have started to adopt the ESG lens for portfolio management. However, broader standardization of ESG measurement metrics and benchmark indices, along with some incentives (like tax status similar to ELSS funds) would help provide impetus as many Individual clients are yet familiar with sustainable investing as a concept. At Citi in India, we are bringing together capabilities across the franchise on the broader ESG themes, to help clients design and execute their ESG priorities, since many of our private banking clients are entrepreneurs, with businesses that are impacted by the ESG focus. We believe a holistic approach is likely to be most successful.
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1. The Guardian, India plans nearly 60% of electricity capacity from non-fossil fuels by 2027, 22 December 2016
The emerging markets universe has 26 countries and, arguably, environmental, social and governance (ESG) matters far more in these regions than in developed markets. There is more room for companies to improve and for investors to influence change, for the good of society and investors themselves. That means greater potential for alpha generation and having a positive impact. Emerging markets rely more on natural resources and have more labour-intensive manufacturing businesses, so there is naturally more opportunity for improvement. ESG standards are beginning to matter more. Consider the growing populations, rising middle class, urbanisation and expanding energy consumption. Clearly you need to improve regulation and governance for these economies to grow in a responsible way. Countries such as China and India are jumping ahead in terms of renewable energy adoption. India has a target of generating 57% of its energy from renewable sources like wind and solar by 2027. [1] ESG investing in emerging markets adds value. Research from the University of Waterloo in Canada shows that the MSCI Socially Responsible Investing (SRI) Index not only ranked higher in terms of mean return than most emerging market portfolios, but also was less vulnerable to negative shocks. [2] Finding “quality” There is a huge spectrum of “quality” – defined in terms of both ESG and investment generally – but I would argue this is greater in emerging markets than in developed markets. Quality businesses look after the interests of investors, employees and society; they manage capital responsibility and have good corporate governance. Well-run businesses can take market share away from competitors such as state-owned enterprises that aim primarily to provide employment and aren’t as competitive. Additionally, there are family-run businesses which studies show tend to generally outperform. While they do not always have great corporate governance, often the family's interests are aligned with investors’ interests in terms of long-term growth and avoiding risk. Clearly, there is also a long list of bad players. While the situation is improving, loose regulations and unstable policy environments do allow bad practice to continue.
With more room for businesses to improve their environmental, social and governance credentials comes greater potential alpha generation, making company selection and data analysis key
Kyle Bergacker, Senior Responsible Investing Analyst
Dara White, Global Head of Emerging Markets
2. Weber, Olaf, and Ang, Wei Rong. “The Performance, Volatility, Persistence and Downside Risk Characteristics of Sustainable Investments in Emerging Markets.”
3. Mention of specific companies should not be taken as a recommendation to buy
Responsible investment (RI) has long been integral to our investment research and decisions and our approach to business more broadly. The rationale for responsible investment is clear: companies with sustainable business models that look to the future have more potential to deliver value to all stakeholders, including shareholders. As a founding signatory of the United Nations’ Principles for Responsible Investment (PRI), responsible investment has been an established pillar of our business for well over a decade. At Columbia Threadneedle Investments, we strive to be responsible stewards of our clients’ assets, allocating their capital within our framework of robust research and good governance. The integration of Environmental, Social and Governance (ESG) considerations within our research builds a fuller picture of the risks and future return prospects of all investment opportunities.
Data analysis Our data models act as a first screen, allowing fund managers to focus their research with greater intensity. A fund manager may, for example, look at a company that the models indicate as being of lower quality but decide it is improving and that is not being picked up by the models quite yet. There is a great opportunity to generate alpha by engaging with these companies to uncover hidden value. That's where our most fruitful dialogue happens. Columbia Threadneedle’s bespoke responsible investment model has more than 250 million data points. We are also working on a platform to go alongside that with more than three billion data points. The data covers about 90% of the MSCI Emerging Markets Index and tells us if a company is making an impact or not. Even if a company doesn't publish a data point, you can infer that through machine learning by capturing related data. For instance, gallons of water used, or hazardous waste emitted. While there is still less data in emerging markets, corporate disclosures are growing quickly in response to pressure from governments and large investors like sovereign wealth funds and pension funds. Emerging market themes Among the themes we are interested in is FinTech, which is an exciting area because it increases financial inclusion across our markets. There are huge benefits in moving from cash to digital transactions, and this transition is happening quickly in some emerging markets and digital payments are the first step towards digital banking. While recognisable names include Alipay and Tenpay – China’s payments duopoly – the likes of StoneCo and PagSeguro [3] in Brazil also enable digital payments. Turning to renewable energy, countries such as China and India are adopting these technologies on a massive scale. Companies in solar and wind have large numbers of potential consumers. Furthermore, China has poured billions of dollars into support for electric vehicles and leads the industry worldwide. There are also opportunities in education companies as there is a big appetite for online education services that give children in rural areas more opportunity.
The power of engagement Engagement is important for sourcing data from companies and helping them to improve ESG practices. We make our views known and help companies to improve performance. Say, for example, you are Coca-Cola and water is a key input. Obviously, reducing water wastage improves your income statement and increases free cash flow. Collaborating with companies helps them to achieve a double win – in terms of ESG performance and financial performance. A lot of policy makers are taking action, setting renewable energy targets as well as introducing stewardship codes. We feel that with the right team and tools there is an opportunity to influence change and be at the forefront of change. We believe it is a great time to dive in and invest in emerging markets using an ESG strategy.
More responsible investment insights here
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1. International Energy Agency (IEA). World Energy Outlook 2018
Recent months and years have once again highlighted the consequences for society of unchanged climate-damaging actions. That's because the directly measurable damages from natural disasters totaled $160 billion in 2019. And in 2020, the figure already exceeded $200 billion. This contrasts with about $915 billion already invested in renewable energy and energy efficiency projects in 2019. But studies [1] [2] have shown that this amount will need to at least triple by 2030-40 to meet the goals of the Paris Climate Agreement - a sum roughly equivalent to France's annual GDP. Entire electricity and heating systems have to be converted from fossil fuels to renewable energy. We need smart electricity grids, modern geothermal, wind and solar power plants, and hydrogen technology to store excess electricity. We’ll also need to invest heavily in cushioning the damage that has already occurred or can no longer be avoided. Sea levels will rise; the only remaining question is: by how much? That means we need flood protection including dredge building and land reclamation. For this, an additional annual investment in the mid hundreds of billions range is needed for these kinds of measures in order to make life with irreversible climate damage possible. We are talking about one of the biggest, tectonic shifts in capital allocation for decades. And so it is little wonder that the biggest climate sinners are taking decisive and targeted action in 2020, e.g. the U.S. by re-entering the Paris Climate Agreement or the European Green Deal as well as tightening of the EU’s 2030 CO2 emission reduction target from previously 40% to at least 55%. Still, a wide range of measures is needed to achieve climate change mitigation from climate, environmental and biodiversity protection, through mobility and industrial policy, to guidelines on energy, aagricultural and consumer protection policies. Support from public institutions and private individuals is needed just as much as commitment from companies with their innovative strength. Hence, climate mitigation and adaptation should offer an attractive investment opportunity in the coming decades rather than just an “investment fashion” for the next few years. Annual average spending on clean technologies has to triple between 2019 and 2040 to still comply with the targets laid out in the Paris Agreement Rising global green energy - Investments in bn. USD / annual averages [1]
To put a brake on climate change and cushion humanity from its consequences, billions will have to be invested worldwide. This could also create attractive return opportunities for investors; and those who can see climate change not just as a destructive force but also as an investment opportunity may find that the investment universe that opens up is larger than it at first appears.
Tim Bachmann, CFA Portfolio Manager at DWS Investment
DWS’ climate tech strategy is considering both parts of the climate change equation – root causes as well as symptoms of global warming. Companies are in focus that offer services and products that help society to adapt to the daily challenges of climate change or to mitigate its consequences. When it comes to mitigating climate change, the main issue is decarbonizing the energy mix - in other words, moving gradually away from fossil fuels. In addition, the decoupling of energy consumption from economic growth through improving energy efficiency or higher energy savings are ranking high on the global environment and climate protection agenda. The first group comprises companies in the power generation and transport sectors, including, for example, wind and solar energy technology suppliers, electricity network operators and smart meter as well as energy storage system producers. Companies that offer energy-efficient and climate-friendly solutions for industrial and household applications are also relevant. Of course, e-mobility and alternative drive systems are a major topic in this area, too. But it’s not only limited to manufacturers of electric cars or fuel cell trucks. Other means of transportation should be considered as well, like railroad operators, bicycle manufacturing or ridesharing platforms. Further, there is high demand for energy-efficient renovation in the real estate sector. This is the result of various building directives, such as the European Union’s regulations on CO2 emissions. Companies that produce and install rock wool and wood fiber insulation materials can be found there. But also companies that develop smart applications for lighting systems or cooling and ventilation technology in buildings are of interest. Solutions that help the mankind to live with the symptoms of climate change can be found in various sub-themes like healthcare, property insurance, water, agriculture or disaster recovery/prevention.
‘Climate mitigation and adaptation should offer an attractive investment opportunity in the coming decades rather than just an ‘investment fashion’ for the next few years’
‘Investors who don’t just see climate change as a hugely damaging event but also as an opportunity are facing a broad investment spectrum’
Farmers must conserve more resources. Due to local water scarcity, the agricultural sector will have to use resources more carefully in future. So-called drip irrigation is an interesting solution to this problem, as is circular irrigation. These systems enable water to be used more sparingly and accurately on arable land. Innovative precision irrigation also has a positive effect on yields. Emerging markets are particularly ripe for conversion, as farmers there often still completely flood arable land. However, water is also becoming a contested resource in the developed world because of climate change. In the USA, for example, up to 944 billion dollars will be needed by 2050 to adapt water infrastructure to climate change. Companies with innovative solutions for the extraction, desalination and treatment of water therefore offer interesting investment opportunities. In the healthcare sector, the medical consequences of climate change also look like something that investors should consider. For example, people are becoming more sensitive to grasses because of the increasingly long pollen season and an increasing air pollution also causes respiratory diseases such as asthma. The pharmaceutical industry therefore needs to produce new medical treatments like allergy tablets or consumer could adapt by installing air purification systems in their homes. Part of DWS’ climate tech strategy is also a thorough ESG analysis which is performed on each individual stock based on various ESG criteria including greenhouse gas emissions, water and waste intensity, labor safety and working conditions or good corporate governance standards. In fact, the ecological component is checked twice. If a company has a good solution in the fight against climate change but can only offer it with unacceptably high CO2 emissions or by violating social standards, those companies are not further considered in the investment process. This approach allows for a capitalization on the secular growth themes within clean technologies, while simultaneously minimizing the risks arising from climate transition, ESG laggards or violators of the U.N. norms. Investors who can see climate change not just as a destructive force but also as an investment opportunity may find that the investment universe that opens up is larger than it at first appears. This is because climate change affects everyday living and people’s way of life across the globe. The topic of climate change has therefore the potential to demonstrate once again how well investors with dedicated funds can reconcile return and sustainability goals.
2. United Nations Adaptation Finance Gap report, May 2016
The effect of the pandemic on ESG investing has been profound. According to the MSCI 2021 Global Institutional Investor Survey, 79% of investors in Asia Pacific increased ESG investments ‘significantly’ or ‘moderately’ in response to Covid-19, ahead of 77% of investors globally. On top of this, 57% of investors in Asia Pacific expect to have ‘completely’ or ‘to a large extent’ incorporated ESG into their investment analysis and decision-making processes by the end of this year. Perhaps most meaningful, and potentially most impactful, is that 90% of the largest institutions – those with more than $200bn of assets – have upped their ESG investments. Already a hot trend, ESG quickly became a high-priority issue, with investors noting that companies and funds with strong ESG scores or mandates performed at least resiliently, and at best shone, in the crisis. ‘Clients continuously demonstrate their appetite to invest sustainably,’ says Joost Bilkes, head of impact advisory and finance department for Asia-Pacific at Credit Suisse. ‘Whether this means investing in impactful companies in private markets or in funds and fund managers that are undertaking shareholder engagement on sustainability issues.’ While the pandemic has been a catalyst, a huge part of this process for the bank is education, which it is well-positioned to provide, both internally and externally. ESG education Credit Suisse’s in-house product training brings relationship managers up to speed on the latest activity and allows them to advise clients on how to integrate sustainability into their portfolios. ‘We produce regular reports and publications that are intended to educate clients and raise awareness of key topics such as the blue economy, biodiversity and education tech,’ Bilkes says. ‘We host client events and conferences, such as the Credit Suisse Asian Investment Conference, produce digestible videos and compelling podcasts, and, of course, inform of any risks or opportunities in the market that can help clients to generate positive, measurable social and environmental impact alongside a financial return.’ As is broadly the case elsewhere, Bilkes says most Credit Suisse clients are at an early stage of their ESG investment journey. ‘We see some clients who have invested in one specific product, such as a thematic fund or a specific impact investment fund investing in Asian SMEs. Meanwhile, other clients are open to approaching this holistically, such as through integrating ESG considerations into a discretionary mandate. These clients benefit from returns that are comparable to those of a traditional mandate, while at the same time holding investments in thematic or impact investment solutions that deliver positive impact.’ Impact investing in Asia While sustainable investing has never been more popular, with investors of all shapes and sizes attracted to the broadening universe of strategies, investing for impact remains largely inaccessible to retail investors. Retail investors can create a sustainable portfolio from the hundreds of sustainable funds across equities and fixed income that are available via typical retail fund platforms. Most impact opportunities, meanwhile, are private market strategies, such as venture capital, private equity and private debt, with varying risk levels. ‘However, there are some impact funds that are available to the broader investor community,’ says Bilkes. ‘These focus on microfinance private debt on the one hand and listed equity funds that do shareholder engagement on the other. ‘But many local trends have become global and vice versa – for example, investing in our oceans or the blue economy, alternative proteins and education technology.’
Joost Bilkes
‘Clients continuously demonstrate their appetite to invest sustainably’
Second impact fund Credit Suisse is capturing trends it has seen across Asia via two funds it has developed with UOB Venture Management: the Asia Impact Investment Fund (AIIF) I and the Asia Impact Investment Fund (AIIF) II. Through its investments, the new AIIF II fund is committed to improving the wellbeing and livelihoods of low-income communities – known as the bottom of the economic pyramid – in Southeast Asia and China. ‘AIIF II will make equity investments of $1m to $15m into private, high-growth companies in sectors such as agriculture, education, healthcare and logistics, or that focus on improving the accessibility of affordable housing, sanitation, clean water and energy,’ Bilkes says. AIIF II has a double bottom-line mandate to achieve meaningful social impact and financial returns. A double bottom line extends the conventional bottom line, which measures fiscal performance, by adding a second bottom line that measures performance in terms of positive social impact. AIIF II raised more than $60m at the first close in the last quarter of 2020. ‘The first round of fundraising closed with amounts raised exceeding AIIF I, proving that investors are highly engaged and interested in the topic,’ Bilkes says. ‘We are closing the second round later this year.’ Bilkes has seen the appetite for impact investing solutions grow steadily in recent years, and he is delighted to see such strong demand for the new impact investment strategy. ‘As testament to the success of the first fund, many of our existing AIIF I investors have recommitted to this new fund, reflecting strong interest to invest in proven solutions that can address the social challenges in Asia, while achieving quality financial returns. ‘We are also observing a broadening of our investor base for such solutions, which now includes ultra-high-net-worth individuals, corporates, family offices and many next generation clients.’ In addition, the pandemic has generated more client interest in professional and dedicated portfolio advice due to lack of time and expertise to manage investments at times of heightened volatility. The demand for advice and expertise is further increased with regard to sustainable and ESG investing, given its relative youth, rapid innovation, and burgeoning frameworks and standards. These factors do not appear to be putting people off from taking a plunge into a world they know little about. ‘In terms of impact investing and sustainability, our clients see it as a long-term trend,’ says Bilkes. ‘There is a growing awareness of global challenges, and how clients address them has evolved over the past years. There is an increasing number of clients looking to integrate their values and social and environmental objectives into wealth management. There have never been so many opportunities to make a real difference.’ Outlook for impact Credit Suisse is seeing tremendous interest in a wide variety of sustainable solutions, as well as demand for more innovative solutions in the space. Furthermore, the greater exposure and awareness afforded to ESG investing in the pandemic, alongside the educational and communicative approach to internal and external dialogue taken by Credit Suisse, means investment appetite is becoming more sophisticated. It now goes beyond traditional exclusionary strategies that exclude from the investment universe sectors and exclude companies proven to have a detrimental impact on society or the environment. ‘In recent years, our clients have allocated more capital towards sustainable thematic and impact investing strategies that focus on mobilising capital for activities that address the UN’s Sustainable Development Goals and generate positive, measurable social and environmental impact alongside a financial return,’ says Bilkes. ‘In fact, assets under management generated from these strategies grew strongly. Credit Suisse has an extensive suite of sustainable solutions across all asset classes, and we are continuously working towards further deepening our sustainability-related offerings, to serve the multifaceted needs of our clients in this space.’
words by Neil Johnson
DISCLAIMER This content is intended for investment professionals and is not for the use or benefit of other persons, including retail investors. Views are as of March 2021 and are subject to change at any time. This is not an offer of, or a solicitation of an offer for any investment strategy or product. All investing involves risk, including the risk of capital loss. This is provided for informational purposes only and should not be construed as investment advice. Investment decisions should consider the individual circumstances of the particular investor. Opinions and/or forecasts contained herein reflect the subjective judgements and assumptions of the authors only and do not necessarily reflect the views of Natixis Investment Managers. No part of this content may be reproduced in any manner without the prior permission of Natixis Investment Managers. In Singapore: Issued by Natixis Investment Managers Singapore Limited (company registration no. 199801044D). In Hong Kong: Provided by Natixis Investment Managers Hong Kong Limited.
As one of the world’s largest asset managers, [1] we are commonly seen as a force for change in helping to protect the environment, enhancing diversity and inclusion, promoting social equality and opportunity, and implementing proper governance to ensure that companies are managed for the long term. It comes as no surprise to us, therefore, to see allocations to ESG-oriented investments increasing at a rapid pace. The trouble is, when investors hear ESG, they each hear something different. And to ensure that managers deliver the ‘right’ level of ESG for investors, investors first need to be clear on their ESG-related conviction. How does it add to performance? Does it have impact – or, how does it affect real world outcomes? How is it implemented in the investment process? Having clarity on those convictions will drive the selection of the ‘right’ ESG approach. Indeed, we believe ESG should not be a one-size-fits-all approach, neither should the elements of ESG be equally present in every investment. Yes, ESG can deliver a number of things, from risk management to performance to real-world impact. But investors don't need glossy photos of windmills to help them understand this. They need transparency to be able to perceive value for money, distinguish one approach from another and, like investment risk, match it to their portfolio needs. At Natixis Investment Managers, we are designed to be diverse. We are keen to make sure that ESG does not succumb to marketing to all investors, rather that it recognises their diverse needs and interests. True responsible investment is about diversity, not divergence; engagement over exclusion; and impact and insight above products. It all comes out in the wash In short, we are acutely aware of the potential for greenwashing and impact washing in our industry. Such has been the flow of industry reports and marketing of ‘everything ESG’ in the past 18 months, it’s easy to be overwhelmed with the surfeit of grandiose claims – none of which should go unchallenged. Perhaps more importantly, there is also the risk of ‘greenwishing’ – because for many ESG strategies it is doubtful, despite the genuine intentions, that they will lead to concrete outcomes, whether financial or in the real world. There are also many issues around the subjectivity of labels, definitions and ratings, as well as a lack of clear standards to measure impact, allow comparison and monitor progress. We recently released a paper titled ‘Can sustainable investing really save the world?’ and have brought together leading academics from around the globe in a bid to provide clients and investors with more nuanced, and evidence-based insights on ESG and responsible investment. Our goal is to cut through the noise of ESG and explore how ideas like blended finance, policy influence and shareholder engagement are becoming key instruments in enabling investors to have a meaningful impact in sustainable investment. Our diverse perspectives on ESG are informed through collaboration – with organisations like the PRI and others outside asset management. Meanwhile, working with those in the industry gives us a certain degree of ‘soft power’ – influencing companies and opening up new investment opportunities. We are convinced that our quantitative and qualitative ESG framework, combined with constant interactions with our affiliates, to proactively identify and act on material ESG issues, are a robust barrier to the risk of greenwashing and greenwishing. Going beyond the basics Natixis Investment Managers has more than 20 affiliates, each with its own culture and investment strategy. Affiliates have full autonomy over the investment process – diversity that allows each affiliate to specialise in areas where they have proven expertise. Having said this, all affiliates are in agreement that ESG integration and active ownership are common sense investment tools, and most affiliates are also signatories of the Principles for Responsible investment, which essentially prescribes these two practices. Some affiliates have also developed specific investment strategies revolving around ESG considerations and offer sustainable or ‘impact’ investment funds. Typically, these funds are based on positive screening or themes (where investments are focused on specific ESG issues, such as water management, job creation, smart cities or climate change). For example, DNCA, Ostrum AM, Ossiam and Mirova all offer ESG-themed or sustainable investment funds – Thematics Asset Management specializes in this ‘thematic’ investing. Sustainable or impact funds have a dual purpose: first, to generate financial returns for investors; second, to create positive, measurable benefits for society or the environment. Our ESG Policy encourages affiliates to be active in this area – provided they set out clear investment objectives, explain how ESG is used to achieve these objectives, and how this ‘conviction’ is translated into the investment process and reporting. We also continue to innovate in ESG products across the group. Mirova, for example, is widely seen as a leader in natural capital investment, while Ossiam has pioneered the application of machine learning to ESG investing; VEGA is now looking to expand into impact investing through a new partnership with Impak Finance. Fundamentally, we believe ESG can make a difference. It can help identify risk. And it can drive financial performance. It can even achieve positive social and environmental change. To do all this, however, asset managers must be clear in their approach – and clear in their purpose and objectives.
Source: Federated Hermes, as at 31 December 2020. Note: The QESG Scores, generated by our Global Equities at the international business of Federated Hermes, rank each stock worldwide in accordance with its ESG risk.
Leading the way in climate reporting Mirova was selected for the PRI Leaders Group 20201, a group of 36 companies considered by the United Nations’ Principles for Responsible Investment (PRI) organization to be at the forefront of 2020’s theme: climate reporting. This announcement is a particular recognition for Mirova’s methodology to measure the carbon footprint of its investments, as well as the main market indexes. The PRI Leaders’ Group is based on a different theme each year. To be considered for the Leaders’ Group 2020, signatories had to demonstrate a strategic approach to aligning their organisation with the FSB’s Task Force on Climate-related Financial Disclosures (TCFD) in their 2020 responses to the PRI Reporting Framework.’ The PRI is the world’s leading proponent of responsible investment, brings together 2,400 signatories, institutional investors and asset managers. Any reference to a ranking, a rating or an award provides no guarantee for future performance results and is not constant over time.
Harald Walkate, Head of ESG at Natixis Investment Managers
ESG can deliver a number of things, from risk management to performance to real-world impact. But making a difference through ESG approaches means thinking beyond quick fixes and a one-size-fits-all approach.
Source: 2020 Natixis IM ESG Report
1. Cerulli Quantitative Update: Global Markets 2020 ranked Natixis Investment Managers as the 17th largest asset manager in the world based on assets under management as of December 31, 2019.
79% of Affiliates regularly engage with companies in which they invest.
93% of Affiliates have policies governing their approach to engagement, voting and/or proxy voting.
Across our Group, Affiliates have integrated ESG into investment processes for nearly 85% of their AUM.
Learn more about APAC ESG asset allocation approach from Fabrice Chemouny, Head of APAC
With sustainable investing becoming the mainstream rather than the exception in the global investment industry, it was only a matter of time before the notionally harder or slower-to-integrate alternative asset classes opened up to ESG. Investor demand and regulatory drivers are accelerating the adoption of ESG principles by alternative asset managers. Meanwhile, most alternative investment assets are held by institutional investors, family offices and high-net-worth individuals due to their complex nature. The widening adoption of ESG principles by governments and private pension funds, sovereign wealth funds, endowments and family offices has become an important driver for increasing incorporation of ESG factors in the investment process of alternative asset managers in recent years. The global race to net-zero carbon emissions in particular is rapidly transforming how institutional investors source and select alternative asset funds, says Fan Cheuk Wan, managing director and Asia CIO for private banking and wealth management at HSBC. A rising number of global and Asian pension funds are applying ESG criteria in their investment process. For example, the world’s largest pension fund, Japan’s Government Pension Investment Fund (GPIF), is a prominent advocate of sustainable investing and has incorporated ESG principles into the investment process for its giant $1.56tn portfolio. GPIF intends to deploy up to 5% ($78bn) of its portfolio into alternative strategies invested in private equity of infrastructure and real estate in the next few years. This exceptional demand has led some of the world’s largest alternative asset managers to include ESG mandates for all their alternative funds regardless of their respective strategies. According to Preqin Pro’s Future of Alternatives 2025 report, Europe remains ahead in terms of ESG integration in alternative investments, with 63% of European private capital firms adopting an ESG policy. By contrast, 37% of total assets invested by private capital firms in North America and 15% of total assets invested by Asia-based funds are managed under an official ESG framework. ‘Driven by increasing investor demand and new regulations underpinned by the net-zero commitments made by Asian governments, we expect the adoption of ESG principles by Asian alternative asset managers to accelerate from this low base over the next few years,’ Fan says. Asia’s alt opportunities Fan sees attractive ESG opportunities in alternatives across the private market investment spectrum in Asia. 2021 is expected to be a pivotal year for sustainable investment due to the global race to achieve net-zero carbon and the 26th UN Climate Change Conference that will take place in Glasgow in November. ‘China has pledged to achieve carbon neutrality by 2060 and this sets the stage for a green revolution in the country. Japan and South Korea have made commitments to achieve net zero by 2050. Singapore also pledged to halve its 2030 peak greenhouse gas emissions by 2050,’ she says. ‘To meet net-zero carbon emission goals, we expect Asian countries to take decisive policy actions to aggressively decarbonise their power and industrial sectors and their transportation sector. This will bring promising investment opportunities for alternative investments that focus on climate solutions, renewable energy and electric vehicles.’ Coal-fired power generation and transportation are the leading sources of greenhouse gas emissions in Asia. This, along with China’s 14th five-year plan featuring the low-carbon transition as a key policy focus, is a vital medium-term driver. These factors are already encouraging a rapid development of clean energy, electric vehicles, climate solutions and green technologies that will bring exciting investment opportunities in hedge funds, private equity, private credit and private real estate. ‘We see plenty of investment opportunities arising from China’s green revolution. The Chinese government has announced it would stimulate economic growth by advancing the adoption of green technologies, as well as upgrading urban infrastructures to mitigate the risks of pollutants and contaminants to the general public. China also unveiled plans to invest in the smart grid in April and attached a strong focus on renewable energy, usage efficiencies and renewable energy storage,’ Fan says. ‘China is the world’s largest market of electric vehicles and number-one manufacturer and installer of solar panels. We believe investors will be rewarded by selecting best-in-class alternative investment funds with robust strategies that take into account ESG best practices.’
Fan Cheuk Wan
‘Driven by increasing investor demand and new regulations underpinned by the net-zero commitments made by Asian governments, we expect the adoption of ESG principles by Asian alternative asset managers to accelerate’
Deep due diligence In Asia, there are challenges to investing in alternative assets that have adopted ESG, with the scale of adoption and range of new solutions in the space being hampered by a lack of standardised ESG metrics, Fan says. ‘Due to a lack of systematic ESG data integration, this has affected the quality and effective use of ESG data. Hence, it’s challenging to quantify ESG in the investment returns. And while the rise of big data and machine learning is improving the quality and timeliness of ESG information available in Asia, alternative asset managers in the region are required to invest more to improve ESG data quality to build trusted performance records and meet due diligence requirements of their investors.’ To this end, HSBC Private Banking has established a robust ESG product due diligence process to select best-in-class alternative funds with a demonstrable commitment to professed ESG principles. ‘For the more illiquid assets in alternative investments, they have longer-term investment horizons and consequently are arguably more exposed to ESG risks. We use a multi-vetted approach to employ qualitative and quantitative methodologies to identify sustainable funds which can truly demonstrate that ESG commitment and principles,’ she says. In its qualitative assessment of ESG considerations, the bank evaluates the sustainable investment philosophy, style, proprietary ESG frameworks and voting policy of the asset managers. Its product specialists also examine the portfolio holdings to ensure the stated KPIs are met and voting does not consistently contradict stated intentions. This stringent product due-diligence process mitigates risks associated with greenwashing, providing a consistent investment approach that can be clearly communicated in the absence of consistent industry definitions. ‘We believe that integrating ESG considerations in alternative investing can deliver real value in terms of enhanced risk-adjusted returns and reduced regulatory risk associated with ESG factors,’ Fan says. Impact and hedge On the back of rising demand from family offices and next generation clients in Asia seeking robust impact solutions, the bank is focusing on impact investments in private markets. In April 2020, it launched its first private equity impact fund to Asian clients. ‘We believe impact private equity funds have a longer investment horizon to capture structural opportunities in the private markets,’ she says. ‘We focus on impact solutions with the goals of achieving positive social and environmental impact alongside competitive financial returns. As more millennials in Asia become involved in the management of family wealth and inherited assets, demand for impact investments is poised to register more rapid growth in the coming years.’ Meanwhile, the global transition to a net-zero carbon economy will generate significant opportunities for companies that offer solutions to mitigate climate change and facilitate decarbonisation. This will also bring challenges to those that fail to adapt their business models to manage climate risks. ‘The low-carbon transition will bring a lot of alpha generation opportunities for hedge funds due to a divergent return outlook for the winners and losers in the global race to net zero. Incorporation of ESG investment methodologies, such as exclusion and positive screening, will help hedge fund managers make investment decisions with consideration of ESG scores and carbon footprint,’ Fan says. ‘More importantly, integrating ESG factors into the investment process is an effective way to mitigate ESG risks in portfolios and reduce drawdowns associated with climate risks.’
For professional investors only. The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results. This is a marketing communication. The views and opinions contained herein are those of Mitch Reznick, CFA, Head of Research and Sustainable Fixed Income, Dr Michael Viehs, Head of ESG Integration, and Tarandeep Panesar, Senior Performance Analyst, and may not necessarily represent views expressed or reflected in other communications, strategies or products. The information herein is believed to be reliable, but Federated Hermes does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Figures, unless otherwise indicated, are sourced from Federated Hermes. This document is not investment research and is available to any investment firm wishing to receive it. The distribution of the information contained in this document in certain jurisdictions may be restricted and, accordingly, persons into whose possession this document comes are required to make themselves aware of and to observe such restrictions. Issued and approved by Hermes Investment Management Limited (“HIML”) which is authorised and regulated by the Financial Conduct Authority. Registered address: Sixth Floor, 150 Cheapside, London EC2V 6ET. HIML is a registered investment adviser with the United States Securities and Exchange Commission (“SEC”).
Back in 2017 we analysed the link between ESG factors and credit spreads [1] in an effort to refine our ability as fixed income investors to more accurately price factors beyond traditional operating and financial risks. We were able to demonstrate that companies with better environmental, social and governance (ESG) practices tended to have lower credit default swap (CDS) spreads, even after controlling for credit ratings and other risk factors. Using the results, we plotted predictions of CDS spreads for given values of ESG scores, drawing an innovative implied ESG pricing curve. In 2018 we published an updated study [2] with a longer sample period which produced similar results. We have recently completed a third study, expanding the sample period to include the period from the start of 2012 to the end of a volatile 2020. We found that the significant relationship between ESG factors and CDS spreads persists: companies with better ESG practices tend to have lower CDS spreads, even after controlling for credit risks. Secondly, the explanatory power of the model increased from both the 2017 and 2018 studies. And finally, high levels of market volatility throughout 2020 did not significantly affect this relationship (a closer investigation of the relationship within 2020 is, however, warranted). The relationship reconfirmed Our latest research shows that even when controlling for operating and financial risks (measured by credit ratings), as ESG factors deteriorate, credit spreads widen. Because the reverse is also true, this relationship has very important investment implications. Figure 1 shows the implied ESG pricing curve using the full dataset from 2012 to 2020. Figure 1
Mitch Reznick, CFA Head of Research and Sustainable Fixed Income
Our results suggest that credit markets are likely to reward companies that make the transition from ESG laggards to leaders with tighter CDS spreads. This observation is particularly poignant given that asset owners and fund managers are increasingly looking to ‘screen in’ companies seen as ESG and sustainability leaders to reinforce the ESG credentials of their portfolios. In this environment, companies with credible transition stories represent an excellent investment opportunity as they join the elite sustainable leaders of their industries. Moreover, according to our credit analysts and engagement specialists, the desire by companies themselves to be ‘screened in’ explains much of their acceptance of sustainability. We believe that senior management who embrace the consideration of nonfundamental factors appreciate that being a sustainability leader brings measurable operational, reputational, and cost‑of-capital benefits. Once, twice, three times you’ve swayed me Having completed this third review, we are encouraged that our pricing model for ESG factors not only remains robust, but its explanatory power has actually increased. What's more, the model has performed effectively through one of the most volatile periods ever in credit markets. This makes us confident that when we use the model in credit committees it is providing that additional precision that we seek. Looking at the trajectory of the implied ESG pricing curve, we can see that in the higher quality QESG categories there is little differentiation in credit spreads (this will be the subject of future analysis). However, at 75 basis points, the difference between high quality and low quality is stark. In multiple terms, the weakest bucket is nearly twice as wide in spread as the strongest bucket. This tells us that the market recognises ESG quality – and dramatically so. Emerging market themes Among the themes we are interested in is FinTech, which is an exciting area because it increases financial inclusion across our markets. There are huge benefits in moving from cash to digital transactions, and this transition is happening quickly in some emerging markets and digital payments are the first step towards digital banking. While recognisable names include Alipay and Tenpay – China’s payments duopoly – the likes of StoneCo and PagSeguro3 in Brazil also enable digital payments. Turning to renewable energy, countries such as China and India are adopting these technologies on a massive scale. Companies in solar and wind have large numbers of potential consumers. Furthermore, China has poured billions of dollars into support for electric vehicles and leads the industry worldwide. There are also opportunities in education companies as there is a big appetite for online education services that give children in rural areas more opportunity. Manage transition risk, but buy transition opportunity The investment implications of the market’s ability to differentiate between low ESG quality and high ESG quality creates real opportunities. While it is important to control for operating and financial risks, we believe buying into credible transition stories can deliver alpha – whilst also benefiting society – as the market recognises an improving ESG story. Our own investors have increased their scrutiny of sustainability credentials, whether mainstream or thematic (e.g. Sustainable Development Goals; Climate Change). Given the rising interest in ESG throughout the investment industry and the surge in sustainability-themed funds and strategies, we see rising demand for the so-called ESG leaders. Demand for sustainability-themed bonds in the primary market is often stronger than for mainstream bonds, suggesting investors are pining for ESG leaders to strengthen the underlying sustainability credentials of their portfolios. With this in mind, we believe buying credible transition stories will deliver alpha as they evolve into leaders and become ‘screened-in’. Our ESG pricing model shows that our investors will be rewarded for identifying these transition opportunities.
1. See ‘Hermes Credit and Hermes EOS Research paper, Q2 2017’
Visit the new Federated Hermes sustainability hub to read the full research paper and to access more in-depth analysis, research and commentary on sustainability, direct from our investment teams.
2. See ‘Pricing ESG risk in credit markets: reinforcing our conviction’
Dr Michael Viehs, Head of ESG Integration
Tarandeep Panesar, Senior Performance Analyst
After missing out last month, David Gait returns this month with a + rating. He is responsible for evolving the emerging markets and Asia-Pacific strategies and is the lead manager on the First State Asia Pacific Sustainability and First State Indian Subcontinent funds. He is also runs the Stewart Investors Asia Pacific Sustainability fund, which is currently rated four out of five in the Morningstar Sustainability Ratings, together with the Sustainable Investment – Overall flag, which explicitly indicates any kind of sustainability, impact or ESG strategy in their prospectus or offering documents. Sustainability is a key part of First State’s approach as it invests in shares of high-quality companies that are positioned to contribute and benefit from the sustainable development of the countries in which they operate. Information technology comprises 23.8% of the fund’s assets and 36.7% of the fund’s holdings are invested in India. The fund ranks 73rd out of 353 funds over three years, with a total return of 32.1%, superior to the average return of 20.7% in the Equity – Asia Pacific Excluding Japan sector.
Corrina Xiao is the head of Taiwan equity investment at Allianz Global Investors. She has 15 years’ experience in the industry, of which 12 have been spent at Allianz. She currently manages the Allianz Global Investors Taiwan fund and previously managed the Allianz Global Investors Taiwan Intelligence Trend fund. This has propelled her to the top fund manager spot in March against her Asia ESG peer group. The fund itself is fifth in the Equity – Taiwan sector with a total return after three years of 93.6%, smashing the average manager return of 48.2%. Morningstar rates the fund five out of five on their sustainability rating and has assigned it the ESG incorporation flag. Allianz have always had a strong approach in integrating ESG considerations into their investment process. They have created a detailed framework with the third version being published in October 2018, illustrating the dedication the company has in implementing referral processes, exclusion policies and a scoring approach.
This month sees Benjamin Ruegsegger receive his first Citywire rating, going straight in with a AAA rating. He is a senior research analyst and runs thematic and sustainable equity portfolios at AllianceBernstein. His AB Sustainable US Thematic Portfolio fund comes in at 146th out of 464 funds with a total return of 67.9%, surpassing the average of 57.6% in the Equity – US Growth sector. Morningstar has awarded the fund a Sustainable Investment – Environmental flag, which indicates that the fund seeks to make a measurable impact alongside financial returns through their investments in companies with a positive environmental record or in industries that positively impact the environment. AllianceBernstein also engages company management teams and stakeholders with ESG considerations fully integrated into their investment process. The firm has 99 employees directly supporting responsible investing initiatives, alongside 140 fundamental research analysts, culminating in more than $450bn in assets under management with full ESG integration.
