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If there’s one thing that has occupied investors in the past 12 months – other than Covid, that is – it’s ESG. How can we do better by the environment? How do we make our societies fairer? And what can governments, companies, and ultimately you, as investors, do to help? Here we delve into a three-letter phenomenon that took the investment industry by storm and led to a fundamental shift in attitudes, objectives and allocations. ESG in Focus shines a light on everything that keeps responsible investors up at night and makes one thing clear aboveall else: the ESG revolution has only just begun.
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Richard Lander Director, Citywire Engage Amy Maxwell Managing Editor, Citywire Engage Joanne Wells Head of UK Business
2020 was a watershed year, can profit and purpose be sustained?
Chapter 1
ESG has arrived
A long-term highly active, growth-focused approach to sustainable investing
Aegon Global Sustainable Equity Fund
sponsored by AEGON ASSET MANAGEMENT
An expanding universe of trailblazing instruments
ESG bonds - a noble initiative that still demands scrutiny
sponsored by eden tree invesment management
Tips on how to improve this integral part of the ESG process
Chapter 2
Fives ways to better engage
Sustainable investors have their say on passive funds’ red hot streak
Are ESG ETFs hitting the mark?
Find an approach to sustainable investing that suits you
Which ESG personality are you?
The moment of proof is upon us. How to evidence sustainable change
Prepare for impact
Sustainable wealth creation that enriches investors, benefits society and preserves the environment
Authenticity in ESG integration
sponsored by federated hermes international
Uncovering attitudes towards sustainable indexing
Sustainable investing: Europe in focus
sponsored by ishares by blackrock
Where to find underappreciated decarbonisation-fuelled growth
Does investing in the low-carbon revolution have to cost the earth?
sponsored by ninety one
Citywire introduces thematic sectors including ecology, clean energy and wate
The sustainable sectors gathering most money
Why paying more attention to the ‘S’ makes economic sense
Empowering the future through social investment
sponsored by nordea asset management
All eyes are on stewardship as the sustainable transition ramps up
Into the future
The performance of ESG strategies might pause for breath after a watershed year, but investors will continue to want more than just a profit from their portfolios. Change that would otherwise have taken years or even decades has happened in the space of a year. The Covid-19 pandemic has accelerated existing trends such as flexible working, online retail and ESG investing. The visible impact of lower pollution levels due to lockdowns, the Black Lives Matter movement following the killing of George Floyd by police officers and a modern slavery probe at fast fashion retailer Boohoo were propelled into the public consciousness. ‘The extensive disruption caused by the pandemic globally has forced us to reflect on what is truly of value in almost every aspect of life,’ said Lucy Kupczak, a portfolio manager at Nexus Investment Managers. ‘This might be the opportunity to reset and make the kind of intuitional changes and policy choices that will lead to a better, greener and more sustainable future.’ Call it ‘ethical’, ‘green’, ‘socially responsible’, ‘sustainable’ or ‘ESG’, investments that score highly for environmental, social and governance factors have soared in popularity. Nexus runs portfolios for Hampshire-based Nexus Independent Financial Advisers and has seen the proportion of clients invested in socially responsible propositions climb from 16% pre-pandemic to 20% today. Cheshire-based Claritas Wealth Management has also seen a significant increase in demand. ‘Admittedly, part of this is probably due to us now asking the question of each and every client, whereas 12 months ago we admit we didn’t,’ said director Tim Walsham. When fears over the extent of the pandemic gripped people and financial markets around the world last February and March, 5% of its clients were invested in its green portfolios. That has since risen to 15% and Walsham expects it to exceed 30% within a year.
Strong performance The recent strong performance of ESG portfolios – in rising markets prior to the sell-off and throughout the crisis, both during the stock market crash and subsequent rebound – has fuelled demand. ‘The outperformance has been particularly impressive and comforting,’ said Sam Buckingham, vice president of investment strategy at Kingswood. ESG strategies tend to avoid sectors that have suffered the most throughout the crisis like oil and gas, airlines, travel and transport, and focus on those that have benefited the most, such as technology, communication and green energy. Their natural tilt towards ‘growth’ as an investment style and companies that harness long-term structural growth trends has also been a major tailwind. Two clients of MBR Wealth Management in Surrey have the same risk profile but the husband has only 30% invested in sustainable funds whereas the wife has 100%. Her portfolio gained 35% in the nine months to 10 February, whereas his is up 23%. The firm removed property from portfolios in favour or renewable energy investment trusts 18 months ago. One-fifth of its clients have sustainable portfolios and director Matt Ryder plans to make this the default option this spring. ‘Responsible funds are integral to future investment,’ he said. Thomas and Thomas Financial in Wales now has more than half of clients in ethical portfolios, up from 45% at the start of 2020, and reports a similar margin of outperformance. ‘Our T&T ethical portfolios grew by double digits across the year and left our T&T mainstream portfolios some way behind, especially in the more cautious space,’ said managing director Darren Lloyd Thomas.
The extensive disruption caused by the pandemic globally has forced us to reflect on what is truly of value in almost every aspect of life
Seamlessly incorporated A further rotation into ‘value’ and more cyclical parts of the market over the next six to 12 months could see ethical portfolios pause for breath and underperform mainstream ones. Lloyd Thomas expects demand to outstrip performance and warns that ‘green investor tourists’ could flock to screened and, therefore, less diverse portfolios based on past performance. ‘These tourist investors could be left staring ruefully at the investments they once held and suddenly sentiment could change,’ he said. Longer-term, however, the outlook for both demand and performance is compelling. Wealth managers point to a conflux of factors, from tougher climate change legislation in economic powerhouses like the US and China, to greater demand for transparency across ESG factors and inter-generational wealth transfer to more ethically minded younger generations. Mark Cleary, director of funds services in Jersey and Guernsey at Zedra, said: ‘Over time, demand will morph from an active request into being seamlessly incorporated by managers in the investment decision-making process. The term ESG will remain for the foreseeable future, but will eventually dissolve into the mainstream.’
Our T&T ethical portfolios grew by double digits across the year and left our T&T mainstream portfolios some way behind
More articles:
Lucy Kupczak, Nexus Investment Managers
Darren Lloyd Thomas, Thomas and Thomas Financial
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sponsored by nordea
Sustainable investing may be the smallest of the ESG categories, but there is no shortage of ambition when measuring its effectiveness. Here are some of the most compelling arguments for delivering greater impact.
Meeting vital needs The world is facing a crisis in water availability and water quality. Water is one of our most precious resources, yet one of the least valued in investment. Although the planet has an abundance of water, less than 1% of the world’s fresh water resources are readily available for human consumption. This goes some way to explain why the fastest-growing sector for impact investing is water, sanitation and hygiene (WASH).
found the financial attractiveness of impact investing relative to other investment strategies at least somewhat important
70%
A rapidly growing market The Global Sustainable Investors Alliance defines impact investing as ‘targeted investments aimed at solving social or environmental problems, and including community investing, where capital is specifically directed to traditionally underserved individuals or communities, as well as financing that is provided to businesses with a clear social or environmental purpose’. Impact investing remains the smallest and most focused of the mainstream ESG categories, but is growing rapidly. The Global Impact Investing Network (GIIN) estimates the size of the market was $715bn in assets under management in 2020, compared with $114bn in 2017.
No performance sacrifice The idea that there is a necessary trade-off between impact and returns is outdated. In a 2020 GIIN poll of impact investors with collective assets of $404bn:
Built on an existing framework Most impact investing equity strategies are based on the UN Sustainable Development Goals (SDGs). The SDGs are an articulation of the world’s most pressing sustainability issues and as such act as the globally agreed sustainability framework. Together they serve to guide the global community’s sustainable development priorities from now until 2030.
reported meeting or exceeding their financial expectations
88%
total SDGs
17
individual targets
169
investable sectors
10
market opportunity in developing countries alone
$2.5tn*
Source: GIIN Annual Impact Investor Survey 2020
Asset managers meeting challenges The recent GIIN survey revealed investors most significant challenges to greater participation in impact investing. ‘Few accessible impact investing fund products’ was cited as the main challenge. The top two most significant gaps highlighted both centred on track record. Greatest challenges when investing through impact investing asset managers:
said ‘a strong financial track record’
42%
said ‘a strong impact track record’
*Source: United Nations Conference on Trade and Development World Investment Report 2014
Putting traditional assets to innovative use In fixed income, green bonds can be classed as impact investing because the issuer publicly states it is raising capital for a defined ‘green’ project.
was a record in 2020 for Green bond annual issuance, with the total market now close to $1tn
$223bn
record was reached for issuance of social bonds, a figure nearly 10 times that of 2019, partly fuelled by the Covid-19 pandemic
$164bn
Turning on the tap Investment opportunities in water can be divided into two areas: increasing the efficiency of water use and ensuring provision and access to safe water and adequate sanitation services.
WASH Financial services (excluding microfinance) Healthcare Food and agriculture Energy
$3,083m $5,667m $2,405m $3,746m $9,007m
$9,735m $16,432m $5,590m $8,284m $19,077m
33% 30% 23% 22% 21%
SDG sector
2015
2019
Compound annual growth rate
people lack safely managed drinking water
2.2bn
people lack safely managed sanitation
4.2bn
people could be displaced by water scracity by 2030
700m
funding gap for achieving water and sanitation targets in some countries
61%
Source: UN
Source: Refinitiv
Assets under management
$715bn
2020
$114bn
2017
Engagement has become a key part of the ESG investment process, but what constitutes best practice? ESG goes way beyond exclusion nowadays – engagement is a key part of the process. ‘It is far better to drive change from the inside by having open and honest conversations with senior management and the board than to walk away and immediately lose any leverage for change,’ said Gemma Woodward, director of responsible investment at Quilter Cheviot. She said that while there are standards to uphold while engaging with companies, there is to no guide on best practice. With a significant degree of variation across the investment industry, ESG in Focus has canvassed investors for their tips on better ways to engage.
Use the carrot – and the stick Being proactive, developing a detailed engagement plan and measuring progress against objectives is generally accepted as the most effective way to engage. Woodward suggests dangling the carrot – but not being afraid to use the stick. ‘Investors have played a critical role in encouraging Shell to set short-term net carbon footprint targets with the pay of its top 150 executives is now linked to emissions-related goals,’ she said. She added that the treat of divestment can be held in an investor’s back pocket as a last resort. ‘The threat of divestment can be held in an investor’s back pocket as a last resort. This has been the approach of the Church of England with its General Synod voting to divest from fossil fuel companies that have not aligned their activities with the Paris Climate Accord by 2023.’
It is far better to drive change from the inside by having open and honest conversations with senior management and the board than to walk away and immediately lose any leverage for change
Understand potential risks Therese Niklasson, head of sustainability at Ninety One, points to the importance of assessing sustainability-related risks amid greater regulatory headwinds, financial-performance impacts, reputational damage and consumer action. Elly Irving is head of engagement at Schroders. In December 2020, her team engaged with seven extractive companies identified as operating in areas in Russia that are at risk of thawing permafrost – a source of greenhouse gases. ‘Together with our data insights unit, we were able to analyse the potential risk down to individual sites owned by these target companies. The information gathered from company responses will not only allow us to better assess companies’ management of these risks, but also to further develop our proprietary tool and monitor how these risks evolve in the coming years.’
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Benchmark knowledge Investment managers who take engagement seriously form long-term relationships with company management and through their own stewardship model can provide what Castlefield Advisory Partners calls a ‘knowledge benchmark’ for a company to identify where it is exceling and falling short. ‘Knowledge benchmarking is all about the disciplined collation and use of data,’ said investment manager Rory Hammerson. ‘Over time, company meetings will start to produce a picture of results that are current in their focus, with performance oscillating around a median. ‘There will be outliers – those companies that spearhead new and better corporate practice – and laggards. A manager who can use this data to analyse corporate cultural change is in a good place to use evidence-based results with company management to make changes where needed.’
Speak the same language Federated Hermes rates the importance of having a team with diverse skills and experience. Its team of multi-nationals includes former company executives, strategy and sustainability consultants, accountants and bankers, lawyers, climate change experts and scientists. ‘We also have advisers with experience of serving on boards of listed companies. This means that we literally speak the same language as the senior executives and board members with whom we’re engaging,’ said Hans-Christoph Hirt, head of its stewardship business EOS. He believes it is also important to interact with regulators, policymakers, stock exchanges and industry bodies to raise corporate governance standards and develop best practice across the market. ‘Over the long term this will improve the understanding of material ESG matters and provide a common framework.’
Report on engagement For EQ Investors, reporting on engagement is just as important as reporting on the impacts of invested companies. ‘To transparently disclose our impact through engagement we have created a milestone system that allows us to track progress [and disclose this] to our clients in our impact reporting,’ said Louisiana Salge, its senior sustainability specialist. Ravenscroft rates the engagement reporting of the team behind the Arisaig Global Emerging Markets Consumer fund. It has engaged on issues such as management compensation, board diversity and single-use plastics. ‘All of its research is published annually in a report that shows each underlying business and its engagement topics as well as details such as meetings and progress status,’ said Ravenscroft analyst Shannon Lancaster.
5
1
2
3
4
Report on engagement For EQ Investors, reporting on engagement is just as important as reporting on the impacts of invested companies. ‘To transparently disclose our impact through engagement we have
Find an approach to sustainable investing that suits you. ESG assets will make up between 41% and 57% of total mutual fund assets across European markets by 2025, according to analysis from consultancy PwC released at the end of last year. The firm also revealed more than 75% of European institutional investors it surveyed in 2020 were planning to stop buying European non-ESG products entirely within the next two years. ESG is more than a buzzword – it is a game changer for the investment industry. The market is still emerging, though, which makes it tricky to navigate. That is why we have broken it down into four distinct approaches. Click over each tab to find out which one most suits you and your clients.
The ethical investor
The moderate investor
The active investor
The innovative investor
The good news is there are plenty of ways into ESG investing. Whether you choose a mainstream fund house with an ESG offering, or a boutique provider specialising in impact investing, the fund choice is rapidly evolving to suit a huge range of needs and objectives.
If your client wants their investment portfolio to reflect their strongly held values and beliefs, consider ethical or values-based investing. Some of these funds were originally faith-based and have their roots in religious movements. Others are broader. They will typically use negative screening to remove companies in industries that might be viewed as objectionable from an ethical or moral perspective. They might screen out companies associated with alcohol, tobacco, gambling, pornography, animal testing, weapons and nuclear power, for example. This type of investing is typically quite personalised, as everyone’s moral compass is calibrated differently. What is acceptable to one investor might not be to another.
If your client requires their investments to stick closely to traditional benchmarks but they are happy to screen out the most unsustainable companies, consider an ‘ESG lite’ approach. By investing in the world’s largest companies, there will be some compromises on ESG issues. These companies will not score highly on every factor, although there is a great deal changing, especially since the pandemic. A moderate approach uses negative screening to avoid companies with the lowest ESG scores. This strategy lends itself to investing in less expensive ESG-themed ETFs and index trackers.
If your client wants to choose companies that rank as the most sustainable according to ESG metrics, as opposed to excluding the ones that rank lowest, positive screening could be the best approach. ESG strategies using positive screening seek out companies that are the best in class and score highly on a range of different ESG metrics, including environmental impact, treatment of workers and business ethics. They also use negative screening to exclude companies with the lowest ESG scoring from their investment universe.
If your client wants their investments to support companies creating solutions to world problems, impact investing could be the strategy to follow. The aim of impact investing is to make a positive and measurable impact on society or the environment, as well as generating a financial return. Some impact investing focuses on funding specific projects, such as microfinance funds to create affordable housing, or green bonds to raise money for a clean water initiative. This may mean the portfolio is more concentrated, and there is a good chance it is riskier too. Investors in this space need to be willing to accept more risk and less diversification.
The moderator investor
Citywire introduces five new thematic sectors with a specific focus on ecology, clean energy and water. In Citywire’s on-going efforts to provide the best data and analytical tools to allow investors to make better investment decisions, we have launched five new thematic sectors, which bring together similar strategies more accurately than ever before. The sectors are: - Equity – Agriculture - Equity – Clean Energy - Equity – Ecology - Equity – Robotics - Equity – Water As more funds are launched into these new categories, the need for better peer-to-peer analysis is paramount. With the explosion of ESG factor investing over the past year triggered by a change in investor behaviour, clean, or renewable, energy and ecology funds reaped the rewards in 2020 in terms of money flows into ecology funds, and returns and money flows into clean energy.
Ecology UK-domiciled, open-end ecology funds saw more than £2.4bn net inflows in 2020, placing the sector in third position for overall sector flows. In Europe, this shift to environment-focussed strategies was amplified with European-domiciled, open-end funds taking in estimated net inflows of £20.8bn in 2020. Chart above shows the flows into the Equity – Ecology sector for UK-domiciled, open-end funds over the past decade. In 2020 the sector witnessed unprecedented inflows of $2.4bn, levels not seen in the previous 10 years. In comparison, 2019 saw outflows of £18 million. The ecology sector aims to capture investments in ecosystems and how we can use the Earth’s resources in ways that leave the environment healthy for future generations. This encapsulates environmental factors including biodiversity, pollution control and natural resource management.
Source: Morningstar - £millions – UK domiciled open-end funds – Equity Ecology
Equity Ecology - Open end - ENF - £m
Clean energy An accelerated trend to come out of the pandemic has been the domination of clean energy. Equities active in solar energy and wind energy were the winners of 2020. Anyone owning stocks in these areas were guaranteed positive returns. Choosing an active or passive strategy in the sector made a difference to the level of returns. Deciding between the two is made complicated by indices with ‘clean energy’ in their name investing in different stocks. The constituents of the S&P 500 Clean Energy Index and the WilderHill Clean Energy Index were hard to outperform for active managers last year. These indices are used as benchmarks in performance analysis on a risk-adjusted basis. Most of the funds we track in the clean energy sector are benchmarked against them. Over the past year, the S&P Global Clean Energy Index returned 134.6%, while the WilderHill Clean Energy Index returned 194.4%. Consider carefully when choosing between the two as there was a huge disparity in returns, albeit both phenomenal.
Water This niche sector plays an important part in two of the UN’s 17 Sustainable Development Goals: ‘clean water and sanitation’, and ‘life below water’. This thematic sector has grown in popularity with ESG investors. With water a basic human need, it plays into the S and E of ESG. The social aspect aims to invest in companies that help meet the world’s need for safe water and sanitation. In particular, the clean water and sanitation goal focuses on solving challenges around the world linked to water scarcity, water pollution, degraded water-related ecosystems, and cooperation over transboundary water basins. The ‘life below water’ goal focuses on reducing marine pollution, protecting and restoring ecosystems, reducing ocean acidification, and encouraging sustainable fishing. Both goals are considered to some degree in many funds active in the Equity – Water sector.
Active managers in the sector currently tracked by Citywire
108
Funds ran between the managers
119
Managers in the sector hold a Citywire rating
38
22
24
19
12
2500
2000
1000
1500
500
0
-500
2010
2011
2012
2013
2014
2016
2018
Nisha Long Head of ESG and cross-border research, Citywire
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They are still a relatively new kid on the block, but that doesn’t mean they don’t have it in them to stir up the investment industry. ESG ETFs have been going from strength to strength last year, with an increasing number of investors turning to passive funds to get their ESG fix. Will their hot streak continue? And what’s the deal with them anyway? We asked five investment experts to weigh in.
2020 was a banner year for ESG ETFs. What's behind the trend?
Kate Capocci Investment manager, Smith & Williamson
Are ESG ETFs a contradiction in terms?
Phoebe Stone Partner and head of sustainable investing, LGT Vestra LLP
What challenges do ESG ETFs face?
Mollie Thornton Investment manager, Parmenion
How big of a problem is the lack of data in the ESG ETF sector?
Angad Lota Investment strategist, The Private Office (TPO)
What’s your favourite passive ESG fund or strategy?
Minesh Patel Director and chartered financial planner, EA Financial Solutions
Capital is starting to flow to companies with solutions to tomorrow’s problems. All eyes are now on stewardship as the sustainable transition ramps up. Milton Friedman was wrong. More than 50 years after the economist’s famous dictum that the sole social responsibility of a company is limited to profit maximisation, environmental, social and governance considerations have moved from the sidelines to the forefront of corporate decision-making. The pandemic has fuelled the run for ESG strategies additionally and led to new highs in investment inflows. According to Morningstar, European sustainable funds pulled in €233bn (£201bn) of new money in 2020, up 84.9% from 2019. While the boom in responsible investing is good news for anyone riding the ESG wave, it has also sparked fears about another boom-and-bust cycle, similar to the dotcom bubble. RWC equity veteran Graham Clapp believes investors who are buying into sustainable strategies could be left disappointed. In a market commentary, he cautioned against eulogising the potential of green low-quality stocks, and warned that the ‘tidal wave’ of ESG flows may not be sustainable.
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The next big thing Lardoux is more concerned about the insouciance of investors who join the ESG hype without doing their due diligence. He gives the example of hydrogen-related stocks, which are thriving on investors’ hopes that they could become the next big thing. ‘There are a few sectors I’m not sure I would get involved in at this stage, and hydrogen is one of them. I’d rather wait until the technology matures and we know more about the role it might play in the future. ‘What we’re seeing at the moment is that lots of people put money in companies or industries they don’t really understand, just because they’ve had a strong performance streak up to now. Usually, that doesn’t make for a great investment strategy.’ But how durable is the current level of ESG outperformance, especially in light of a possible commodity comeback? Commodities have been out of favour for the best part of a decade, but the dog days may be over. Since the lows of March last year, the industry has seen a broad-based upswing in everything from energy to materials and food, with some experts already predicting another supercycle. As investors bet on a global economic recovery, ESG stocks could be left out in the cold. For others, the current drilling and mining bonanza is nothing more than a last hurrah for a dying sector. In a report from January this year, Lei Wang, a senior credit analyst at Aviva Investors, states that ‘there is no growth story’ for oil majors. ‘These companies have been burning cash for decades. Whenever they have had free cashflow, it has come from selling assets. In fact, many are busy acquiring renewable assets and will let their oil and gas production decline.’ Gemma Woodward, director of responsible investment at Quilter Cheviot, said fossil fuel companies in particular are unlikely to spoil the ESG party. ‘In our view, it’s better that those businesses are in the hands of shareholders who are going to hold them to account, as opposed to being owned by shareholders who are like: “Climate transition? Who cares?” Instead of just leaving them on the side, we would rather have the stewardship with those companies and see how they handle that transition, because a lot of them do have solutions for the future.’
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‘Many companies at the heart of this trade are loss-making and keep warning on profits, yet shares keep rising.’ According to Clapp, the situation could become ‘more extreme from here’. He warned that ‘the more detached share prices become on the way up, as we are seeing now, then the more extreme the moves can be on the way down’. Damien Lardoux, EQ Investors’ head of impact investing, believes fears of an ESG bubble are overblown. He doesn’t see the danger of a speculative mania in the sustainability space, not least due to the all-encompassing nature of the ESG theme itself. ‘You can basically put an ESG overlay on any stock,’ he said. ‘But even if you narrow down the universe and only focus on so-called ESG leaders, I’m not worried about an overheating market.’ He argues that ESG leaders tend to exhibit ‘quality characteristics like low leverage and good visibility on earnings’ that justify higher valuations. ‘Those companies are definitely worth a premium because they are better run than their peers. There are certainly some parts of the market that are richly priced at the moment, but I don’t think there’s a bubble as such.’
Annual European sustainable fund assets (in €bn)
Source: Morningstar
ESG in numbers:
1250
750
250
Inflows into European ESG funds in 2020, from €126bn the year before
€233bn
Number of newly launched ESG funds in Europe last year
505
Assets in European sustainable funds in 2020, up 52% on 2019
€1.1tn
Launched in 2016, the Aegon Global Sustainable Equity Fund is a high-conviction growth-focused portfolio of 35-45 companies, with the theme of sustainability running through each position. The Fund is managed by Andrei Kiselev, Malcolm McPartlin and Audrey Ryan of Aegon AM’s 27-strong equity team, supported by the firm’s 14-strong Global Responsible Investment Team. The Fund is an evolution of Aegon Asset Management’s 30-year heritage of managing specialist ethical and sustainable funds. Citywire interviewed co-manager Malcolm McPartlin and support manager Audrey Ryan about the Fund.
What is the background to the strategy? MM: When we launched the Fund in 2016 it was with the clear objective of it being the best global equity fund in the market, rather than just the best ESG-focused fund. This is because we believe that generating alpha and delivering a positive ESG impact are not mutually exclusive. Our performance to date has demonstrated this view. As a summary, the Fund invests in sustainable growth companies which are providing solutions to long-term sustainability challenges. We utilize Aegon AM’s independent Responsible Investment team and its unique sustainability analysis framework as a core part of our fundamental research process. What makes Aegon AM a leader in this field? AR: We have over 30 years’ experience of managing specialist ESG funds. As an organization we believe that responsible investment practices generate value over the long term. Consideration of Environmental, Social and Governance (ESG) factors is a core element of our investment analysis and decision-making process, as well as our stewardship activities. Our Global Responsible Investment team provides independent oversight across our funds and supports the management of our Global Sustainable Equity Fund. The team also leads our engagement activities. What is the fund’s investment style? MM: We take a highly active, growth-focused approach to sustainable investing and we do so with a long-term perspective. Many of the sustainability challenges we face will take years or even decades to address, so we must look beyond a company’s next quarterly results. We build the portfolio from the bottom up without reference to the index, meaning we can pursue the most exciting and innovative growth companies globally regardless of sector or region. Within our growth style we have a balance between what we term as ‘structural’ and ‘cyclical’ growth. This helps to diversify the portfolio and means it is not all concentrated in a narrow range of stocks sharing the same characteristics. The fund also has a significant tilt towards small and mid-cap stocks, as we typically find many exciting sustainability opportunities here. This means we are a good complement for other funds which have more of a large-cap focus. What has driven the strong performance since launch? AR: Stock selection has been the key driver of performance. We focus on factors that we think are unappreciated by the market, including the sustainability of returns, addressable markets and potential inflection points. We have greatly benefitted from the idea flow and interaction between the fund managers and our 27-strong equities team. Sustainability analysis by our independent Responsible Investing team is also key, as it helps us to identify these unappreciated sources of long-term alpha. We view sustainability as an additional source of alpha, providing a long-term tailwind to performance. What sustainability challenges are you trying to address? MM: These are many and varied, so we think it’s important to keep an open mind when investing. Ultimately, the question we always ask ourselves when we start looking at a new company is ’what sustainability challenges is the company trying to address?’. We have seven broad ‘pillars’ of sustainability which we use to categorise each holding in the fund. There are three environmental, three social and one governance pillar, but the weighting in each pillar changes over time and we never have target weightings. It is an outcome of the process rather than an input. Currently we are excited about areas such as clean energy and transportation, precision medicine and the use of IT as an enabler to address sustainability challenges. Why don’t you hold any of the large-cap technology stocks known as FAANGs? MM: These companies do not fit the philosophy of what we are trying to do in the fund. They are undoubtedly successful, but we do not see a compelling sustainability angle to any of them. We think there are much clearer ways for us to invest in sustainable growth companies with tangible positive impacts. What role does engagement play in your strategy? AR: It is key and is an area in which we have significant experience and resources within our Responsible Investment team. Our engagement activities span: • Pre-investment - where a company could have a positive impact, but needs to improve; • Post-investment - where we push existing holdings to improve on weaker areas; and • Thematic engagements - where we use our scale as a global asset manager to encourage better standards across the whole market. The beauty of engaging with younger and smaller companies, which naturally have a sustainable mindset due to the nature of their products, is that these tend to be more receptive to engagement and willing to improve. Finally, what makes your fund different? MM: We tend to be more growth-focused and less large-cap focused than most peers. This is driven by our desire to look beyond the widely held sustainability companies and find those improvers that will become the leaders of tomorrow.
This might be the opportunity to reset and make the kind of intuitional changes and policy choices that will lead to a better, greener and more sustainable future
Malcolm McPartlin Co-manager, Aegon Global Sustainable Equity Fund
Audrey Ryan Support manager, Aegon Global Sustainable Equity Fund
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For Professional Clients only. Capital at risk. Please refer to the KIID and/or prospectus or offering documents for details of all relevant risks. Past Performance is not a guide to future returns. Opinions and/or example trades/securities are used to promote Aegon Asset Management's investment management capabilities: they are not investment recommendations, research or advice. This marketing is not prepared in accordance with legal requirements designed to promote the independence of investment research, and is not subject to any prohibition on dealing by Aegon Asset Management or its employees ahead of its publication. Aegon Asset Management Investment Company (Ireland) Plc (AAMICI) is an umbrella type open-ended investment company which is authorised and regulated by the Central Bank of Ireland. Aegon Asset Management UK plc (Aegon AM UK) is authorised and regulated by the Financial Conduct Authority. Aegon AM UK is the investment manager for AAMICI and also the marketer for AAMICI in the UK where the fund has notified the FCA for a temporary permission. This article is marketing and does not constitute an offer or solicitation to buy any fund(s) mentioned. No promotion or offer is intended other than where the fund(s) is/are authorised for distribution.
Aegon Global Sustainability Equity Fund
q&a with:
Responsible and sustainable investments have come of age and are experiencing ever-increasing demand. The COVID-19 pandemic has served to accelerate this trend, as investors rightly seek to address societal needs, in tandem with longer-held environmental concerns. Global accords, such as the Paris COP21 agreement and new regulations specifically targeting sustainability considerations, such as 2020’s European Union Taxonomy, are also playing a vital role in driving demand for innovative ways to address climate change and or other pressing issues affecting societies around the world. While equities have perhaps been the dominant focus for responsible investment, the fixed income asset class has quietly been addressing these challenges through a series of innovative debt securities that have Environmental, Social and Governance (ESG) outcomes woven into their fabric. These trailblazing instruments, whose universe has since expanded from green bonds to include social and sustainability bonds, enjoyed a surge in popularity in 2020 - which arguably spawned wider issuance of sustainability-linked debt and furthered the development of transition debt finance. Whilst still accounting for a small fraction of overall global debt issuance, the growing status of ESG integration underlines the greater focus being placed on how companies tackle both social and environmental issues. It is a hugely positive inflection point for fixed income, but be that as it may, we have to acknowledge that despite their ESG labels, these instruments are just as susceptible to ‘green-washing’ as their equity counterparts. With rapid market growth comes the requirement for responsible and sustainable investors to interrogate the attributes of these instruments, as well as the values of the companies they are financing. A robust investment framework that integrates such factors is paramount. It is our long-held belief therefore, that it is equally important to conduct thorough due diligence on these vehicles, with such analyses also considering the issuing entities’ corporate practises, cultures, as well as their strategic vision from a responsible & sustainable perspective, instead of relying solely on ESG labels. It can also be argued that while green bonds often have clear, quantifiable and almost universal target metrics, such as a reduction in C02 emissions, the same is not always true for social bonds. In fact, the sheer breadth of societal issues that social bonds support introduces an added layer of complexity – particularly for those lacking a robust responsible and sustainable investment framework. At EdenTree, a ‘profit with principles’ ethos is core to our approach, evidenced by an award-winning responsible and sustainable investment heritage. Not only have our portfolios sought to meet clients’ financial objectives via diversified portfolios of high quality debt instruments since inception therefore, but they also set out to ensure that underlying issuers are suitable as determined by our proprietary screening criteria. The latter are both values-based, to enforce absence of harm by exclusions as well as ‘responsible’ in nature, including pillars such as Environment & climate change, Corporate governance, Business ethics and Human rights. Where sustainability can be integrated under the themes of Education, Health & Wellbeing, Social Infrastructure and Sustainable products or solutions, investment opportunities are routinely sought and seized upon. As a consequence, EdenTree’s Fixed Interest fund range actively invests in green, social and sustainable bonds whose proceeds are deployed towards projects with clear and verifiable positive environmental impacts, funding initiatives that target specific societal issues or segments of the population and sustainability-led undertakings combining both green and social elements. We are also proud patrons of the Retail Charity Bond market, a platform though which UK-based charities seek unsecured debt funding to further their impact across the country. Whilst these charity bonds may lack an official ESG label, we believe they are just as worthy to merit inclusion into our portfolios. In keeping with this more holistic stance, our ongoing monitoring of investments also goes beyond financial performance to include periodic reviews that gauge companies’ direction of travel with respect to our responsible and sustainable investment objectives. Where necessary, we engage with companies to better understand material risks, encourage best practise and catalyse positive change. This puts our clients in a prime position to attain ESG benefits alongside financial returns.
David Katimbo-Mugwanya Senior fund manager, EdenTree Investment Management
The value of an investment and the income from it can fall as well as rise as a result of market and currency fluctuations, you may not get back the amount originally invested. Past performance should not be seen as a guide to future performance. If you are unsure which investment is most suited for you, the advice of a qualified financial adviser should be sought. EdenTree Investment Management Limited (EdenTree) Reg. No. 2519319. Registered in England at Benefact House, 2000, Pioneer Avenue, Gloucester Business Park, Brockwell, Gloucester, GL3 4AW, United Kingdom. EdenTree is authorised and regulated by the Financial Conduct Authority and is a member of the Investment Association. Firm Reference Number 527473.
From its 1983 inception, the international business of Federated Hermes has been at the forefront of responsible investing. Here, Michael Viehs, Head of ESG Integration, explains why the delivery of Sustainable Wealth Creation has and always will be the firm’s core purpose. Interest in ESG has grown exponentially recently but has been important to Federated Hermes for decades. Can you detail some milestones? Since our first CEO openly challenged a major UK company to improve its governance, to our current leader Saker Nusseibeh being awarded a CBE for services to responsible business, the international business of Federated Hermes has always been at the forefront of responsible investing. But, I guess, some milestones that stand out are: - The establishment of our dedicated stewardship team, EOS at Federated Hermes, in 2004 – coining the term ‘engagement’ to help explain stewardship to international investors. Today, with $1.3tn in assets under advice, it is now a world-leading stewardship provider; - We led the working group that developed the Principles for Responsible Investment (PRI) and in 2006, when they were launched, we became a founding member; - In 2014, in an industry first, we established our Responsibility Office; and - Placing responsibility, integrity and client focus at the heart of everything our people do, we established the Federated Hermes Pledge in 2015, which compels us, as employees, to put clients’ interests first and to act responsibly and transparently. Why is it important to behave in such a responsible manner? For us, it’s part of our DNA – the delivery of Sustainable Wealth Creation that enriches investors, benefits society and preserves the environment – for current generations and those to come – has always been our core purpose. For wider industry, however, it has become a reputational issue in recent years. Increasingly, asset owners are requesting responsible and sustainable products. But it’s important to authentically integrate ESG in decision-making because, put simply, it is the right thing to do. Of course, there is plenty of academic studies to support such an approach – and our proprietary research has also proven that when you do it correctly and genuinely, you’re also able to deliver financial outperformance over the longer run as well as positive societal outcomes. Looking back over 2020, how did the ESG landscape change? The year 2020 in general and in particular the Covid-19 pandemic accelerated a social awakening in the industry. Issues such as human capital management, employee wellbeing, and also diversity and inclusion, all topics that are part of the “S” in ESG, moved into the spotlight. Previously, much of the focus had centred on climate change, environmental damage and biodiversity loss. But last year showed the importance of human capital for companies and investors alike. During the pandemic, employee wellbeing has been important. Another big topic is diversity, particularly gender and ethnic diversity. These are topics we have long been engaging on – and they are an important value drive for companies. How often and actively do you engage? Our global stewardship team, EOS at Federated Hermes, which has $1.3tn in assets under advice, is a core part of our business – and our investment teams’ approach. For example, last year, it engaged 1,245 companies, made over 120,000 voting recommendations, and held over 150 discussions with regulators and stakeholders. However, it’s important to understand that almost half of its engagements are now more than nine years in duration. So, EOS is committed to realising positive, enduring change. It also has a team of 67 with diverse industry experience, enabling them to engage thousands of companies on material ESG considerations, advocate for positive change, making businesses more sustainable and thereby more financially successful in the longer term. Through the team’s constructive engagements and company dialogues, it gains unique insights – something that cannot be provided by a backward-looking third-party ESG provider. What do you do with the information gleaned from your engagement? An authentic and credible ESG integration approach by asset managers necessitates the consideration of qualitative engagement insights; insights obtained from a dialogue with key corporate decision makers such as executives and the board of directors on financially material ESG considerations. The qualitative engagement insights gathered by our engagement team are a crucial input for our investment teams. Not everything in the ESG space can be quantified and therefore the qualitative engagement information becomes very important for an authentic ESG integration approach. A lot of stakeholders in financial services want to quantify sustainability, but this isn’t always possible. You need a qualitative overlay beyond ratings from third party providers to make an accurate assessment of the true sustainability performance of investee companies and assets. Third-party ratings aren’t useless, but for us they are just the starting point. We then ask our fund managers and analysts to do their own fundamental, bottom-up ESG research. It’s important that we focus our research efforts on those ESG considerations that are financially most relevant for the particular asset or company that we are analysing. There’s a lot of ESG information for public equities and fixed income, but if you look at private markets – direct lending, real estate, infrastructure or private equity, all assets that we have in our product pipeline – it’s much more difficult to obtain ESG data. For those asset classes, it is even more important that the investment teams to do their own fundamental research on material ESG considerations and factor in the thematic and sectoral ESG insights from our stewardship team. As the ESG space becomes increasingly competitive, how do you intend to continue to differentiate yourself? To date, we’ve invented innovative proprietary ESG analysis tools and published pioneering research on the effectiveness of ESG and stewardship integration. We continue to be innovative. For example, we have a carbon tool to assess a company or portfolio’s carbon footprint and a portfolio snapshot tool that looks more broadly at the ESG performance of companies. Further down the line it’s going to be important to provide more incisive information on water, waste, air pollution and social topics like diversity and human capital management. Being able to not only talk about ESG on a very high level but in a very granular sense will be a key differentiator. Everyone is talking about the acronym ‘ESG’ but our understanding of all the different granular sub-ESG themes and our ability to engage with companies on them to create a positive impact will continue to be our secret sauce. We continue to track and prove the positive impact of ESG investing and stewardship through our continued research efforts. To read more about Sustainable Wealth Creation and how Federated Hermes incorporate ESG into their investment process, please visit the new Federated Hermes sustainability hub.
Michael Viehs Head of ESG Integration, Federated Hermes
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. The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other communications. This does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
Between March and June 2020, Censuswide surveyed 400 professional portfolio builders across the UK, Italy, Germany and Switzerland to uncover attitudes towards sustainable investing and the role of sustainable indexing. Sustainable is the new standard Climate change, wildfires, and the Covid-19 pandemic have shown an increasing impact on European investors. Climate risk is now widely embraced as an investment risk and transitioning from traditional investments to sustainable ones is quickly becoming imperative, especially for those investing for the long-term. As a result, an unstoppable transition to sustainable investing is now in progress with 78% of European and 81% of UK investors already integrating sustainability into their portfolios.
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Source: Censuswide, iShares Sustainable Investing Research, June 2020. For illustrative purposes only. Note: Total may not add up to 100%, as respondents could pick more than one factor.
Source: Censuswide, iShares Sustainable Investing Research, June 2020. For illustrative purposes only.
It’s time to act Many of our clients are under pressure to transition their portfolios to be more sustainable and this was confirmed in our survey with 80% of European investors placing the incorporation of sustainability into their portfolio construction strategies as either urgent or very urgent. • Investors in the UK: 84% • Investors in Italy: 85 % • Investors in Germany:78% • Investors in Switzerland: 72% Future first We asked investors what the driving forces are behind this urgency to transition portfolios.
Whether it's due to ethical considerations, corporate beliefs, client demand or potential return opportunities, sustainable investing is reshaping portfolio models.
Challenges to change Transitioning to sustainable investing is not without its roadblocks. We identified 3 main challenges professional investors are facing today: 1. Lack of confidence in ESG data and ESG scores 2. Choosing the right sustainable investment vehicle 3. Choosing which fund provider to work with A crucial role As investors seek more sustainable investment avenues, indexing has naturally come to the forefront and 80% of the investors surveyed believe indexing is crucial to achieving a more sustainable portfolio.
To uncover why investors believe indexing will play such a crucial role in helping them achieve more sustainable portfolios we asked them why they currently choose indexing.
Indexing: Clarity in complexity Our research tells us that as investors transition into sustainable investments, navigating the choice, terminology and data interpretations can be challenging. We believe an important reason why so many investors are turning to indexing, is because indexing can help provide the clarity and simplicity investors need to pursue their specific financial and sustainability goals.
The sustainable indexing investment revolution has started. Visit iShares.com to download the full research report and learn why we believe indexing provides investors with the clarity they need to build more sustainable portfolios.
With Tesla’s stock price increasing more than seven-fold in 2020 and stellar gains for some solar-energy equities, many investors are asking whether shares in companies linked to the green revolution have lost touch with reality. We manage an equity strategy that invests in companies we expect to benefit from efforts to tackle climate change, so we understand the concern. We don’t hold Tesla in our portfolio. But we do own shares in other companies whose products help to avoid emissions from transport, as well as from electricity generation, factories, offices, homes and other sources. Fortunately, we think there are plenty of companies making the global economy more sustainable whose shares still represent good value. But it’s increasingly important to invest selectively. Capturing decarbonisation-fuelled growth Conceptually, the case for investing in businesses whose products address the world’s carbon problem is straightforward. ‘Decarbonising’ the economy requires far-reaching changes to the way the world produces and consumes, which will present enormous opportunities for some companies. From an equity perspective, the idea is simply that these companies may be able to outgrow their peers, so their shares have the potential to outperform. The faster the low-carbon transition occurs, the more we’d expect these stocks to outpace the market. Last year saw a big acceleration of decarbonisation, despite (and in some ways because of) the pandemic. Among the major developments, China, Japan and South Korea committed to ‘net-zero’; the EU put clean-tech at the heart of its COVID-recovery plan; and the UK adopted one of the world’s most ambitious carbon goals. Capping a breakthrough year in climate policy, Joe Biden’s US election win brought to power a president with a strong environmental agenda. Not surprisingly, this boosted the shares of companies seen as well-placed to benefit from the low-carbon transition. Varied valuations Given governments’ determination to reduce emissions – coupled with consumer preferences for sustainable products, and the fact that green technologies are becoming better and cheaper – we think the rationale for investing in decarbonisation is stronger than ever. But are the shares of ‘carbon-avoiding’ companies now overpriced? It’s certainly true that shares generally became more expensive last year. The strong gains for global equities in the latter part of 2020 were accompanied by an increase in the price-earnings ratio of broad benchmarks like the MSCI All Countries World Index (ACWI). The companies we focus on (again, which don’t include Tesla, but all of which help avoid emissions) were no different. Their average valuation also increased, but only in line with the MSCI ACWI’s valuation gain, although their share-prices went up by more than the index. In fact, the gap between the two valuations, which is usually fairly slim anyway, narrowed slightly. Clearly, for the difference between the two price-earnings ratios to remain stable, the above-market price increases of the decarbonisation stocks must have been accompanied by correspondingly higher earnings. What does this tell us? First, it shows that investors are no more excited about some stocks with the potential to benefit from decarbonisation than they are about shares generally. We think this is because the market is yet to grasp the economic transformation that tackling carbon emissions requires. A few green-tech companies and sectors dominate the headlines, but the low-carbon revolution occurring across industries is still largely being overlooked. Second, we think it confirms that a selective approach to investing in decarbonisation is crucial. Some low-carbon areas look expensive to us, including some hydrogen and residential-solar businesses. But parts of the electric-vehicle supply chain, for example, are still being priced in line with the traditional auto sector, rather than tomorrow’s transport system (and nowhere close to Tesla’s lofty valuation). Of course, whether any stock represents good value depends on how successful you think the respective company will be. But we might all agree that there are multiple ways for investors to align a portfolio with the low-carbon growth trend. And they needn’t come with a hefty price tag. All investment involves risk; losses may be made. We seek to lead the conversation on sustainable development, assisting our clients on their journey towards sustainable long-term investing. For further insights visit ninetyone.com/GlobalEnvironmentFund
Graeme Baker Co-Portfolio Manager, Ninety One Global Environment Fund
Deirdre Cooper Co-Portfolio Manager, Ninety One Global Environment Fund
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So far, ESG investing has been dominated by the environment. But with social issues increasingly prominent, investors should take a second look at the “S” in ESG. Sustainable investing is on its way to becoming the new normal. While inflows into ESG-focused funds increased dramatically over the past years, the focus was mainly on the "E", with environmental concerns very much to the fore. At the same time, social aspects – the "S" in ESG – were often neglected by investors. However, in recent months, the realization that the environment is only one aspect of ESG seems to be gaining ground. Social aspects are becoming more and more important - and for good reasons. The Covid catalyst There’s no doubt that the Covid-19 pandemic is one of the main catalysts of this development. The importance of our healthcare and education systems has never been clearer. And many social divisions have been sharply exposed by the unequal way in which the burden of Covid has been spread. At the same time, the pandemic has cast a harsh light on the practices of many companies forcing them to reconsider how they treat their employees, their customers, their supply chains and society at large. Meanwhile, the global protests that we witnessed last year have underscored the urgent need for social justice – and for countries and companies alike to combat prejudice, foster diversity and promote equal opportunity. A shift driven by stakeholders The shift in perceptions of social issues is being shaped by stakeholders – whether they are shareholders, employees, or ordinary members of the public. Retail investors are increasingly conscious of where their savings are going, and this is particularly true of the younger investors who constitute Generation Z. So there is growing pressure on companies to improve their social performance. UN’s aspiration for closing the funding gap In 2015 the UN defined 17 sustainable development goals (SDGs) to address the world's most pressing questions by 2030. No fewer than 11 of them are related to social concerns. With the UN attaching such great importance to social issues, investors might wonder if they shouldn't be doing the same. Especially because paying more attention to the "S" also makes economic sense: an estimated annual investment of USD 5-7trn is needed to bridge this social gap. At the same time many social solutions are economically viable and generate attractive returns with demand increasing rapidly. This offers a huge reservoir of opportunities and growth potential for companies from which investors can benefit. Making the “S” in ESG investable Offering investors a vehicle to capitalize on this strengthening trend was the trigger for Nordea to launch the new Global Social Empowerment strategy. The investment team, which has been very successfully managing the Nordea Global Climate and Environment strategy for more than twelve years applies the same investment process and philosophy to find companies that can offer solutions to growing social challenges. The team has defined three broad areas of particular focus. Each of these addresses a huge swathe of the world’s population, highlighting the scale of the global opportunity. • Vital Needs: companies that provide minimal basic resources for long-term wellbeing, including water and sanitation, food and affordable housing. • Inclusion: companies that promote human capital, improve digital connectivity, and build infrastructures to support economic, technological and social inclusion. • Empowerment: This topic focuses on solutions that empower people with resources to create lasting wealth and improve their wellbeing. Areas of importance here are health solutions, innovations in productivity and financial engagement. Companies that can deliver effective solutions in these areas will be very well placed to capitalise on the resulting growth – to the benefit of the investors who back them. Thomas Sørensen, co-manager of the Global Social Empowerment strategy, describes investment in these areas as providing an “unmatched opportunity”. “This is win-win,” he says. “By investing in businesses that provide social solutions, investors can have a positive impact on society while achieving sustainable and positive long-term returns.*” In the years ahead, the “S” in ESG looks set to become the next theme investors will turn their attention to. And as with any long-term investment trend, the greatest opportunities are available to those who get in early. *There can be no warranty that an investment objective, targeted returns and results of an investment structure is achieved. The value of your investment can go up and down, and you could lose some or all of your invested money.
David Crawford CFA, CAIA, Co-head of institutional & wholesale distribution, Nordea Asset Management UK
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