COP26 TOPS THE AGENDA IN
OUR BUMPER 2021 ESG REVIEW
ALL EYES ON
leaders flying in from around the world for two weeks of high-pressure negotiations aimed at steering us onto a new path to a safer climate.
But it’s not just politicians who can make a difference. As investors, there are ample opportunities to ensure capital flows in the right direction. Backing companies that respect our planet’s boundaries and are helping innovate our way out of this crisis not only makes societal sense but also increasingly makes economic sense ― the stellar performance of many ESG strategies throughout the pandemic served as the first real proof point.
In this special issue, we speak to the wealth and fund managers getting to grips with the long-term future drivers of the global economy. We hear how they are putting money to work while navigating incoming regulation, avoiding greenwashing and deciphering some monumental geopolitics.
ESG REVIEW 2021
THE TIME HAS
COME FOR ACTION
ith COP26 just days away as we went to press, the themes and messages within our ESG Review 2021 couldn’t be more timely.
The crucial UN summit held in Glasgow this November will see world
ESG anyone? Sustainable funds
are on the up
ESG regulation moves forward but there is much more to be done
Where next for ESG?
Energy security takes centre stage
J. P. Morgan Asset Management
Managing editor, Citywire Engage
Editor, Citywire Wealth Manager
Chief sub-editor, Citywire Wealth Manager
Matthew Ely & Mark Critchell
ESG anyone? Sustainable funds are on the up
ESG regulation moves forward but there is much more to be done
Where next for ESG?
Energy security takes centre stage
ESG strategies outperformed during the Covid-19 selloff, but how have they fared during the recovery? And can they provide a hedge against inflation?
By Kathrin Schindler
Covid has shone a light on social and environmental issues like climate change and inequality,’ George Lake, portfolio manager at Cazenove Capital, said.
‘Corporates, governments and asset owners have been galvanised and are now working harder than ever to make progress. This is the first time we have seen all the required actors pointing in the same direction, which we believe is contributing to the enormous growth in popularity.’
The pandemic has certainly fanned the flames of responsible investing, but is it enough to keep the fire burning?
Chris Anker, head of sustainability at RWC Partners, phrased it carefully: ‘I would consider it likely that demand will stay strong in the current environment. A market reversion away from quality and growth, however, could put ESG funds under pressure.’
He warned that the consideration of ESG risk factors does not give investment managers twenty-twenty vision, nor does it guarantee the delivery of returns while solving the needs of wider society.
‘There is very little evidence of premia attached to revenue streams that support the delivery of the UN Sustainable Development Goals,’ he said.
He cautioned against glorifying ESG in the wake of Covid-19 and pointed out that established approaches are often the true drivers of performance within ESG funds.
‘The enhancement of existing investment processes to consider non-financial risk criteria may simply accentuate pre-existing style factors rather than introduce new risk premia.’
Sustainable funds are on the up
loomy predictions that sustainability-focused mandates would fall by the wayside when Covid-19 swept the globe did not come to fruition, thankfully. As it stands, ESG funds are far from sinking into obscurity. According to The Investment Association, they raked in new client cash at an average rate of £1bn a month in 2020, with sector assets hitting £56bn at the end of January this year.‘
Corporates, governments and asset owners are now working harder than ever to make progress
George Lake, Cazenove Capital
The pandemic has increased the hype around responsible investing and has served as the first real proof point for ESG strategies. At first glance, they passed the test with flying colours. After analysing 26 ESG exchange-traded funds and mutual funds with more than $250m (£184m) in assets under management, S&P Global Market Intelligence found that 73% of them had outperformed the S&P 500 in the year to March 2021.
There are caveats, though. According to Trustnet, three-quarters of sustainable or ESG equity funds underperformed their average peers in the final months of 2020 and the first quarter of 2021, with only 25% of ESG strategies beating their peers between January and March this year. Much of that drop has to do with the rotation from growth to cyclical industries like energy, financials and materials, sectors that are typically underrepresented in ESG funds.
On a year-to-date basis, however, sustainable strategies have pulled their weight, aided by the post-pandemic recovery.
‘ESG funds have done really well,’ Frederik Kooij, CIO at Tribe Impact Capital, said.
‘Yes, they sharply underperformed in February and March, but they’ve come back handsomely.’
So handsomely, in fact, that they are ‘probably on par with the wider fund market today’, as Ben Palmer, head of responsible investment at Brooks Macdonald, put it.
‘We can split it into two periods: underperformance in the first quarter of the year and a catch-up from then until now,’ he said.
While the positive performance of sustainability-focused mandates has further kindled the enthusiasm around ESG funds, it also fuelled the debate about greenwashing. When asked whether he believes that ESG window-dressing is going to pick up in light of recent developments, Kooij responded with a laconic ‘for sure’.
‘The incentive for mis-selling to customers is only growing because of the wall of money that’s coming into ESG,’ he warned.
‘Many firms with legacy organisations don’t have a large ESG team or understanding built into their decision-making process, so it could be a combination of wilfully exaggerating what they’re doing and exaggerating what they’re doing under ignorance.
’From Palmer’s perspective, the rising popularity of ESG funds doesn’t necessarily lead to an increase in greenwashing. He sees a lack of clarity and understanding around the use of certain terms as a systemic problem that is unrelated to isolated trends and has less to do with hoodwinking investors.
‘ESG is not a homogenous thing, so there’s often a misunderstanding of what a strategy is aiming for,’ he said.
‘That’s where a lot of claims of greenwashing emanate from. In most cases, it comes down to confusion and poor communication or research rather than fund houses trying to lie to people.’
Instead of worrying about a post-pandemic uptick in greenwashing, Palmer urges investors to not lose sight of the bigger picture. For ESG funds to keep outperforming their benchmarks, they need to adapt to a new set of opportunities that goes beyond the classic ESG territory.
Average returns for Europe-domiciled sustainable funds
Source: Morningstar Direct; Morningstar Research. Data as of 31 August 2021.
The ESG gravy train
A focus on improving the sustainability impacts of your business shows a longer-time mindset and an understanding of the future drivers of the global economy
Ben Palmer, Brooks Macdonald
A lot of column inches around global warming focus on transitioning our energy system away from fossil fuels to renewable sources, but there needs to be an increased focus on some of the less obvious carbon-intensive industries,’ he said.
‘Nutrition and agriculture, for instance, are smaller themes in most portfolios that we think will grow over time.
’Spurred by the pandemic, the need for strong public and private healthcare will also increase in his opinion.
‘We’re facing a healthcare challenge with significant economic impacts. There’s going to be mounting support for healthcare provision over the medium term,’ he said.
The shift to clean energy poses another rich hunting ground for ESG investors.
‘This transition requires $120tn of investment,’ Cazenove Capital’s Lake said.
‘Competition for capital is already driving, and will continue to drive, innovation in the private sector over the next decade and beyond.’
He has added opportunistically to a number of sustainable infrastructure companies focused on wind, solar and energy storage and increased exposure to high-quality growth equities within his sustainable multi-asset portfolios.
Alas, ESG funds are not a cure-all. Many of them may be able to ‘make this world a better place’ as their marketing campaigns suggest, but their ability to protect against rising inflation risks is limited.
‘It would be wonderful for an ESG fund to say it has the silver bullet and can also serve as a hedge, but there’s no way you can credibly argue that,’ Kooij said.
‘If inflation becomes more of a theme instead of just a temporary blip, we’ll certainly see the value part of the index do better for longer. Judging from what we witnessed in February and March, that wouldn’t be such good news for the ESG sector as a whole.
’While Palmer agreed that, over the short term, traditional growth-focused ESG funds are likely to fall behind their more cyclical-oriented counterparts in an environment of high inflation, he pointed out this might be an overly simplistic view when considering longer timeframes.
‘Absolutely, structural inflation will prove challenging for certain businesses in the growth sector. But in general, companies that are addressing their ESG footprint have it in them to weather the storm better than others,’ he said.
‘In our opinion, a focus on improving the sustainability impacts of your business shows a longer-time mindset and an understanding of the future drivers of the global economy. That increases the likelihood of being able to provide sustainable, growing revenues, and growing revenues can act as a natural hedge to inflation.’
Global Head of Stewardship & Sustainable Investing
Recent history shows that sustainability does have an impact on market returns. Our own research showed that highly rated ESG firms outperformed in the 2020 market crash. Our findings support the hypothesis that a company’s focus on sustainability is fundamentally indicative of its resilience. We expect this correlation between market performance and sustainability to strengthen in future.
That’s why at Fidelity, for companies and sectors that fall outside of our principles-based exclusion list, we have a strong preference for engagement over exclusion. We believe we can create more positive change by leveraging our size and scale - and exercising our rights of ownership - to improve the focus of management teams on sustainability issues. Given the breadth and depth of global capital markets, we believe exclusion simply moves this responsibility to another capital provider, who may or may not have the same incentives and goals.
But for engagement to be meaningful, it must go beyond simply sending an email to a generic company inbox. Our approach adds value by demanding direct dialogue with leadership teams.
In 2020, we conducted 923 ESG engagements with 716 companies, including 152 meetings with chairs and non-executive directors. Key themes included executive remuneration, governance, and climate change. We also voted at over 3,800 shareholder meetings globally, opposing management at around 28% of the meetings.
*Our fundamental research plays a pivotal role in highlighting material ESG risks that present an opportunity or requirement to engage with a company.
We classify our engagement activities within three broad categories:
WHY A SUSTAINABLE FUTURE DEMANDS
t’s becoming increasingly clear that simply reshaping capital flows towards more sustainable companies isn’t going to be enough to resolve the urgent environmental and social issues we face. What will make a difference is a fundamental change in corporate behaviour, enabled by meaningful stewardship. For this reason, we place active engagement at the core of our approach to sustainable investing.
Improving investor outcomes
Direct company engagement - where we engage with an individual company on a specific issue relating to their operations.
Thematic engagement - where we engage with a number of companies at once, aiming to accelerate progress on broad sustainability issues that cut across different sectors and regions, such as climate change and supply chain sustainability.
Collaborative engagement - where we work with other asset managers, policymakers or industry bodies to drive corporate change on critical issues. By collaborating we can maximise impact to advance the way industries are regulated and companies are managed.
For example, we may pursue an engagement based on a sustainability rating we’ve assigned to a company, or a broader industry-level risk we have identified. This comes from close collaboration between our analysts - who are experts on individual stocks and sectors - and our Sustainable Investing Team, who supplement this knowledge with insights on broader ESG themes.
Once we have identified an engagement opportunity, we then create an engagement plan. This is done at the outset of each engagement, with defined goals, objectives and milestones, as agreed by our investment team. The Sustainable Investing Team, supported by our portfolio managers and investment analysts, will then spearhead constructive dialogues with companies to explain our beliefs and expectations, and encourage shifts in long-term behaviour.
We subsequently follow-up through regular meetings with company management to ensure that our engagement activity is effectively driving more sustainable practices. Where companies fail to improve against agreed goals or there is a pattern of deteriorating sustainability scores, we would then review our holding, with the ultimate option of selling our position if adequate progress isn’t being made.
Our engagement efforts are focused on three key sustainable investing themes:
• Understanding nature-based risks as part of tackling climate change
• Looking after employees, supply chains and communities
• Redefining ethics for a digital world
Through active engagement we are playing our part in phasing out financing for coal-fired power plants. In 2018 we initiated a thematic engagement with banks on their financing of such plants in Asia. Initially, we focused on Singaporean banks, but we have since expanded our engagement to banks in Japan and China.
We have also been working with a market-leading logistics company - ZTO Express - on improving their sustainability credentials. Our successful dialogue with them has helped to integrate more sustainable practices into their daily operations: improving disclosures, moving to biodegradable packaging, and transitioning to a carbon-efficient logistics fleet.
When it comes to issues of employee welfare and improving sustainability of supply chains, we are putting pressure on companies to take greater accountability, not only for the welfare of their employees, but for the community at large, and for the individuals in their often complex supply chains.
In 2020, we led a large collaborative engagement of a group of 85 investors, representing over $2tn in assets, on the humanitarian crisis of 400,000 seafarers stranded at sea. We engaged with shipping companies, charterers, and airline companies in our portfolios and co-signed a letter to the UN. By May 2021, the number of stranded seafarers had halved to 200,000. Our work here continues.
We are also working hard to raise our own sustainability standards. Fidelity has a stated goal of being net-zero as a business by 2030. We strongly believe that is important to live by the standards we set. Our long-term dedication to raise our own ESG standards also gives us more credibility when we ask investee companies to do the same.
Planning and monitoring engagements
Our engagement process
Our areas of focus
This information is for investment professionals only and should not be relied upon by private investors. The value of investments (and the income from them) can go down as well as up and you may not get back the amount invested. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. The status of a security’s ESG credentials can change over time. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document (KIID), current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM1021/37088/SSO/NA
Lead Portfolio Manager
Federated Hermes Sustainable Global Equity Fund
FEDERATED HERMES INTERNATIONAL
A: The fund was opened to investors from June 2021.
It was launched as part of Federated Hermes’ product line reclassification and expansion which aims to provide clarity to investors by aligning with EU regulation.
The EU’s Sustainable Finance Disclosure Regulation, the first part of which went live in March, aims to address the lack of consistency in information and stands to provide a competitive edge to those firms offering genuinely sustainable products.
Therefore, the clearer positioning of the fund makes it easier for investors to identify it as a sustainable offering – something that is becoming increasingly important considering the recent proliferation of ESG-related products in the market.
The pandemic has been another contributing factor for the launch of this fund. In response to the global health crisis, we have seen a welcome and marked acceleration in demand for responsible and sustainable investment strategies. Many more investors have become alive to the urgency of the climate crisis and want to be active participants in addressing it.
It’s important to note that while the fund is newly launched, it has a world-leading stewardship provider behind it in Federated Hermes, which has a legacy dating back to 1983.
INTRODUCING THE FEDERATED HERMES SUSTAINABLE GLOBAL EQUITY FUND
Q: When and why was the fund launched?
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. For professional investors only.
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.Issued and approved by Hermes Investment Management Limited which is authorised and regulated by the Financial Conduct Authority. Registered address: Sixth Floor, 150 Cheapside, London EC2V 6ET.
Backing companies helping to create a more sustainable future, this brand-new strategy is built on a 40-year track record in sustainable investment, explains lead manager Martin Todd
A: Ingrid Kukuljan and Henry Biddle are co-portfolio manager and deputy portfolio manager respectively. Ingrid is Head of impact and sustainability at Federated Hermes and has over 22 years of experience in financial services. Henry, meanwhile, has experience running Federated Hermes’ US SMID Cap strategy so has a background in searching for companies underneath Wall Street’s radar.
We are also fortunate in being able to draw from the best ideas of a large analyst pool. The 40 stocks in the portfolio have 14 different covering analysts.
Q: Who runs the fund with you?
A: The Federated Hermes Sustainable Global Equity fund is a high-conviction strategy that invests in companies helping to create a more sustainable future.
The fund follows a ‘best ideas’ strategy built on our 40-year track record of sustainability and investment. The stocks in the portfolio come from three alpha sources: sustainable leaders, impactful companies and future leaders. In other words, we only invest in companies that make a difference.
Each theme is aligned with one or several of the UN’s Sustainable Development Goals (SDGs). To make these links, we leverage the combined resources of more than 50 people within Federated Hermes, all of whom are experts in their field and skilled at identifying truly sustainable investment opportunities that are consistent with the UN’s overarching framework.
Q: What makes the strategy unique?
A: We have our own proprietary process for incorporating the UN SDGs. This enables us to identify the best stock opportunities
through four thematic lenses: efficient production and resource use, social inclusion, environmental preservation, and health and wellbeing.
Q: Which of the 17 SDGs is the fund most focused on?
Sub-themes within these areas include:
A: Broadly, it consists of four stages. We start with exclusions to narrow down our investment universe. Then we apply our thematic filter, based on the four lenses mentioned previously. Next comes the fundamental analysis to find the companies with the growth potential, financial resilience, ESG integrity, management quality and vision. We also assess how these companies are aligned with the UN Sustainable Development Goals and whether they meet our sustainability criteria.
We think about our sustainability criteria in three broad terms. First, is the business model aligned with a better future? Second, how does the business manage its ESG responsibilities, and how is it changing? And finally, do their products generate impact? Do they help to benefit people and the planet?
Q: Can you explain the investment process?
A: Within Federated Hermes, we work in collaboration with our world-leading stewardship business, EOS, where we are supported by 38 engagement professionals with dedicated engagers per theme within the fund. Environmental preservation is looked after by Sonya Likhtman, health and wellbeing by Amy Wilson, efficient production and resource usage by Lisa Lange, and social inclusion by Roland Bosch.
As a team we are committed to realising positive, enduring change and the numbers speak for themselves. In 2020 alone, we engaged with 1,245 companies tallying up 123,988 voting recommendations. It is this pioneering engagement that we believe delivers insights beyond ratings.
Q: How do you engage with companies?
A: The Sustainable Global Equity fund has twin financial and sustainability objectives. It offers thematic exposure to companies that we consider to be leaders in environmental or social products and services, or those that are trailblazing the transition to a zero-carbon world through the concrete steps they have taken and continue to take to lessen their impact on the environment.
There is a clear set of exclusions to ensure that potentially harmful activities cannot be invested in. These include businesses involved in fossil fuels, weapons, tobacco and gambling, which are automatically screened out.
Q: Are there any automatic exclusions within the fund? And if so, what are they?
A: Sell discipline is vital when managing any investment fund, which is why we have strict criteria to ensure we balance long-term ownership with not falling in love with a stock. Four scenarios tend to play out in this regard.
1. There is fundamental change within the business. This usually entails a change of leadership or a radical change in strategy. On further investigation, if we find that the original thesis has been broken we would close our positions.
2. Substitution/opportunity cost: we will replace a holding if we identify another stock with a more compelling risk/reward profile. Given this is a very concentrated portfolio, it’s something we monitor regularly.
3. We have valuation concerns. We would exit a position if its price discounts future growth potential.
4. Sustainability standards are not met. Once concerns emerge, we monitor and would ultimately exit a position if significant progress is not made.
Q: How do you know when its time to sell a stock?
A: I’ll answer this simply with three standout statistics pulled from our ongoing research.
90% of the cost of capital studies show that sound ESG standards lower the cost of capital.
88% of the reviewed studies show that solid ESG practices result in better operational performance.
80% of the studies show that stock price performance is positively influenced by good corporate social responsibility practices.
Q: Why is ESG about more than a feel-good factor?
The introduction of the Sustainable Finance Disclosure Regulation has been a good first step, but wealth managers bemoan the lack of overall standardisation
By Selin Bucak
While environmental, social and governance (ESG) considerations have become mainstream for many fund managers, it has so far been driven by businesses themselves. A big milestone this year was the introduction of the Sustainable Finance Disclosure Regulation (SFDR), which came into effect on 10 March 2021 in Europe and requires mandatory ESG disclosure obligations for asset managers marketing funds within the European Union.
Although this means there is now at least a formal framework for sustainability-related disclosures, it still places the bulk of the responsibility on asset managers themselves to classify their own fund products into one of three categories that relate to sustainability factors.
‘Regulation is going to steer things in a better direction, but the problem of greenwashing is going to be persistent. A lot of it comes down to subjectivity and I don’t know how regulation can iron that out,’ said Eric Williamson, investment manager at Tam Asset Management.
For Williamson, it can be a double-edged sword as regulators try to fit rules onto something that for one person can be classified as sustainable but for another is not.
The implementation of SFDR this year is just the first phase of an evolving regulatory initiative. Phase two of the rules will see additional disclosure requirements at entity and product level come into effect from July 2022.
According to Kate Elliot, Rathbone Greenbank’s head of ethical, sustainable and impact research, the real test of SFDR’s success will be when these Level 2 rules come into force ‘and funds have to report on the ESG data underpinning their top-level classifications’.
She added: ‘We’re broadly supportive of efforts to standardise definitions of terms such as “ESG” and “sustainable”. However, the challenge then lies in ensuring the regulatory framework is sufficiently clear and robust that it brings clarity to the market rather than muddying the waters further.
ESG REGULATION MOVES FORWARD
But there is much more to be done
ustainable investment regulation is moving in the right direction, trying to bring sense to a market that has so far been like the Wild West, but regulators need to ensure it doesn’t unintentionally muddy the waters further, industry insiders have warned.
A lot of greenwashing comes down to subjectivity and I don’t know how regulation can iron that out
Eric Williamson, Tam Asset Management
Assessment of funds
SFDR has helped lay the groundwork for the categorisation of funds, according to Rob Morgan, pensions and investments analyst at Charles Stanley, with managers already using Article 8 and 9 (categories under the regulation indicating where a fund sits on the sustainability spectrum) as shorthand in their presentations. For more information, click the plus button on the left.
But it hasn’t changed Charles Stanley’s fund selection process too much.
‘The process for responsible funds is exactly the same as it would be for a standard fund but it’s adapted in our fund research capabilities. On top of the investment credentials we’re thinking about and asking questions in terms of their philosophy and process. We’re trying to avoid greenwashing situations,’ he said.
New is not always better
We like to see in-house proprietary research going on rather than bought from an agency.
We tend to favour active over passive as a
result of that
Rob Morgan, Charles Stanley
He added that the team prefers to do its own research rather than take standard ESG ratings at face value. Key to his evaluations is seeing how well resourced a team is.
‘Anyone can construct a portfolio and put a badge on it that’s well rated by an agency, but not everyone can answer your questions in terms of how they’re applying this philosophy in the real world and what decisions they’re taking that are benefiting environmental factors or social factors.
‘We do in-depth research to satisfy ourselves there is adequate resource going into it and it’s not simply an overlay or box-ticking exercise. We like to see in-house proprietary research going on rather than bought from an agency. We tend to favour active over passive as a result of that.’
Rathbone Greenbank’s Elliot agrees. She argues that while third-party data sources can be a useful starting point, they will only get investors so far.
Using Morningstar or MSCI ESG data, it’s possible to do an initial
filtering down of the universe of funds, she said, but the team at Rathbone Greenbank still like to conduct their own analysis and due diligence. This is particularly to understand the scope of any ethical or sustainability criteria that’s applied to the fund, the expertise and track record of the fund management team, and the underlying holdings.
‘This ultimately is the real test of whether a fund’s ESG approach will meet the needs of a given investor,’ she said.
Delyth Richards, head of client solutions group at Kleinwort Hambros, pointed out that, while there are many branded tools available, such as MSCI ESG ratings and S&P Trucost, there is ‘no gold standard for reporting’. For example, carbon impact can be measured in a variety of ways, with everyone having their own preference. The Weighted Average Carbon Intensity measure is favoured by the Financial Conduct Authority in the UK.
Sustainable funds have been seeing record flows, with €1.15tn (£840bn) in investor cash invested in ESG strategies, according to a report earlier this year from the Association of the Luxembourg Fund Industry. There were 495 new sustainable funds launched in 2020 and 284 repurposed sustainable funds.
With so many new strategies coming to market, Tam’s Williamson feels more comfortable investing with managers who have been investing sustainably or focusing on ESG for longer.
‘There are a lot of ESG funds popping up and we’ve been quite sceptical of the newer ones because of the risk of greenwashing,’ he said.
‘We are more comfortable investing with ones that have been doing this for longer as they have processes they have developed over a long period of time.
’Favoured managers are Rathbones, which has been a ‘good provider of ethical funds’, particularly in bonds, the Baillie Gifford Positive Change fund and BMO’s sustainable equity income funds.
‘Ultimately, the tools we use are meetings with fund managers. When it comes to ESG investment, we keep due diligence up to make sure they are adhering to the strategy they say they are implementing and we will look at underlying holdings.’
The SFDR applies to funds that are marketed to EU investors. Those based in the UK, or anywhere else, will also need to comply with the regulation, even though the rules themselves have not been adopted by the country’s regulator.
Richards said they are ‘deep in the process’ of reviewing and comparing the UK versus EU disclosure regulations as there are differences in the approaches and gaps across some of the scope.
‘Lack of consistency is widely acknowledged, and earlier this month the IMF [International Monetary Fund] published a report reconfirming that massive new investment will be required to achieve 2050 goals, that proper regulatory oversight and verification mechanisms are essential to avoiding greenwashing, and a key element will be harmonising of climate disclosure standards,’ she said.
The UK watchdog has also recently issued a ‘Dear chair’ letter to
authorised fund managers setting out how current rules should be interpreted with respect to ESG and sustainability. It set out guidelines on the design, delivery and disclosure of funds, while pointing out that many of the applications it receives are poor quality.
A further review of the guidance will assist the industry, according to Richards, ‘with supplemental guidance for asset managers outlining how their strategy should include how climate-related risks and opportunities should be factored into relevant products and risk management – to include better data availability, and metrics, including how metrics have changed over time’.
ESG regulation moves forward but there is much more to be done
SFDR has provided three high-level labels for funds, with the goal of preventing greenwashing, at least partially. The classifications are:
Article 6: funds that do not integrate sustainability into the investment process, so can hold investments in anything from fossil fuels to tobacco.
Article 8: funds that promote environmental or social characteristics, but they do not need to have them as overarching objectives of the strategy.
Article 9: funds that have as their primary objective an environmental, social or governance impact, which means the majority of investments will be made into such companies.
Four months after the regulation was introduced, Morningstar analysis found 21.8% of the nearly 82% of funds available for sale in the EU were classified as Article 8, while 2.8% were classified as Article 9, accounting for nearly €3tn in assets.
iSHARES BY BlackRock
EUROPEAN INVESTORS’ TOP 5
icture a snowball rolling down a hill, getting bigger and gaining momentum the longer it travels. The shift towards sustainable investing is our snowball. And it is gathering momentum – European investors expect nearly 50% of their assets under management to be sustainable by 2025, compared with 21% in 2020.¹
1. Transitioning portfolios
Building a sustainable portfolio tailored to specific requirements can be time-consuming. It is also challenging for investors to assess their current portfolio against ESG metrics and then determine which product substitutions will make their portfolio more sustainable.
When you invest with iShares, you get access to the broader added value, experience and expertise of BlackRock.
• Our Portfolio Analysis and Solutions team can help evaluate your portfolio’s holistic sustainability profile to assess your portfolio
against ESG metrics.
• We can evolve your portfolio’s sustainability metrics with product substitutions, using alpha-seeking, factor and index sustainable funds.
• We can build a sustainable proposition based on your sustainability objectives.
FOR PROFESSIONAL INVESTORS ONLY
Capital at risk.
The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) only and should not be relied upon by any other persons. Issued by BlackRock Advisors (UK) Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Registered in England and Wales No. 00796793. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock. © 2021 BlackRock, Inc. All Rights reserved. 1876481
1 BlackRock, “Sustainability Goes Mainstream, 2020 Global Investing Survey”, EMEA results, December 2020, Survey of 425 clients representing USD25T in AUM.
² BlackRock, as at 30 June 2021, EMEA Client Sustainability Survey
³ BlackRock’s 2020 sustainability actions
⁴ BlackRock Global Business Intelligence, as of 30 June 2021.
⁵ BlackRock, Bloomberg, as of 30 June 2021.
⁶ Munich Re NatCatService database (as of 30 March 2021).
⁷ BlackRock Investment Stewardship; Protecting our clients’ assets for the long-term, July 2021.
However, sustainable investing is complex, with no one-size-fits-all approach. After conducting over 100 client interviews², we identified five challenges that European investors face with the shift towards sustainable investing:
2. Making sense of the data
Sustainable data, metrics and calculations vary per provider and interpretation differs – all of which makes it difficult for investors to quantify the sustainable output of their investments. Investors need to trust that a provider is taking a robust, rigorous approach when assessing the quality and accuracy of ESG data.
In 2020, we added 1,200 sustainability metrics to Aladdin, our risk and portfolio management system, and established multiple partnerships with data analytics firms.³ This data feeds into our risk management platform and our investment process – from research to portfolio construction, modelling, and risk management and reporting.
At iShares, we are committed to offering transparency, consistency, and expertise with analysing and interpreting ESG data, driving a push for standardisation across the industry.
Climate change has emerged as a crucial factor for investors to consider; it is widely recognised that climate risk is investment risk
In the first half of 2021, 48 sustainable ETFs launched industry wide in Europe alone.⁴ With a growing number of sustainable investment products available, investors need sustainable ETFs that are built with quality at the forefront, with a provider that is aligned to local regulations and the fast-changing sustainable landscape.
The BlackRock Sustainable Investing framework classifies iShares ETFs and index products according to four sustainable approaches.
With more sustainable ETFs registered on more European stock exchanges than any other provider, iShares gives you choice to select the fund that meets your needs and clarity through our sustainable investing framework.⁵
Climate change has emerged as a crucial factor for investors to consider; in fact, it is widely recognised that climate risk is investment risk. In 2020 alone, natural disasters led to an estimated US$120 billion in damages – the highest ever recorded.⁶
Broad building blocks
3. Choosing the right product
4. The emerging climate trend
But along with other ESG principles, investors often aren’t sure how to incorporate climate considerations into their portfolios.
BlackRock has three approaches to climate investing to help investors navigate our range and select the best climate option for them.
Reduce exposure to carbon emissions or fossil fuels
Prioritise Investments based on climate opportunities and risks
Target climate themes and impact outcomes
Funds that seek to track indices that eliminate exposure to certain business areas.
Funds with an explicit ESG objective, which may include a targeted quantifiable ESG outcome.
Funds that focus on a particular Environmental, Social, or Governance theme.
Funds that seek to generate a measurable sustainable outcome, alongside a financial return.
For illustrative purposes only. The above list is not exhaustive but represents various ways investors can take specific climate objectives into consideration
5. Company engagement
We firmly believe in the value of engaging with companies. When BlackRock engages a company, we do so from the perspective of a long-term investor. Engagement enables us to have ongoing dialogue with companies and build our understanding of the challenges and opportunities they face. This is particularly important for our clients invested in indexed funds, as they typically remain invested in a stock for as long as it remains in an underlying index – often many years.
iShares is backed by BlackRock’s Investment Stewardship team that engages with companies big and small, and at all stages of their sustainability integration journey. Engagement is one way the team advocates for sound corporate governance and sustainable business models that can help drive the long-term financial returns that enable our clients to meet their investing goals. In 2020–2021, we held more than 3,650 engagements with over 2,300 companies.⁷
BlackRock’s investment stewardship toolkit involves engaging with companies, voting in our clients’ interests and providing transparency in our activities.
To learn more about investing in sustainable ETFs, search ‘iShares ESG’
J.P. Morgan Asset Management
J.P. MORGAN ASSET MANAGEMENT
At COP21 in 2015, the Paris Agreement was adopted, which gave all nations around the globe an opportunity to commit to targets that would address climate change. They agreed that they would revisit the agreement every five years; COP26 is that opportunity for everyone to come back to the table, see what plans we have in place and how much more aggressive we can be.
HOW TO INVEST
TO MAKE A DIFFERENCE
OP26 itself is already a key step in the fight against climate change, says Katie Magee, investment specialist at J.P. Morgan Asset Management. Still, all economies have a lot of work to do to make an impact. What’s the role of the asset manager in reaching the ambitious goals set by the climate change agenda?
What does COP26 mean to you as a large investor?
prepared to address climate change and for the transition to a low-carbon world, such as those focused on managing their carbon emissions, water and waste. We also look at how companies are managing the physical risks of climate change and any potential reputational risks. We still invest across every sector, but in a less carbon-intensive way.
We have a heritage of active management that considers all financially material risks in the investment process.
A heritage of innovation that continues today
images sourced by citywire
From an investor’s perspective, this could have a meaningful impact on markets for several reasons. For example, if governments and policymakers agree to a higher price on carbon or introduce more carbon taxes, that’s going to have an impact on the bottom line of every company that emits greenhouse gases. At the same time, if they’re investing more in subsidies for greener energy, that could really benefit the companies that are already moving in that direction while also potentially benefiting global GDP growth.
Climate change is at the top of our agenda when we think about the biggest impacts on investor portfolios over the next year, five years and even decades. One way we are incorporating climate change considerations into client portfolios is by building carbon transition-aware strategies. We know that our investors’ portfolios are going to be impacted by climate change and any actions that come out of COP26. We seek to invest in companies that are best
Where do you invest to push the climate change agenda forward?
We do incorporate minimum safeguard exclusions, such as norm violators, weapons manufacturers and tobacco industries. But when it comes to climate change, we don’t feel that excluding large sectors entirely from our portfolio is the right way to make an impact. Instead, we lean into the winners and underweight the laggards because we believe that engaging as invested stakeholders with the companies that need to make the biggest change will be the more successful approach to mitigating climate change.
For example, we need to reduce greenhouse gases emissions, but global demand for energy is actually increasing as more countries develop. Simply divesting from the energy sector pushes the problem on to someone else. Instead, we should be engaging with these companies and pushing them in the right direction; they could be the ones developing some of the innovative solutions that we need to see to address this challenge.
Do you exclude certain sectors or divest from others?
We prepare portfolios for the carbon transition by looking at how companies are thinking about their carbon emissions, but also how they approach climate-aware strategies to managing their own businesses.
We prepare portfolios for the carbon transition by looking at how companies are thinking about their carbon emissions, but also how they approach climate-aware strategies to managing their own businesses. By investing more in companies that are that are moving in the right direction, and avoiding or underweighting companies that are not, we can build a broad, well-diversified global equity portfolio that seeks to limit carbon emissions.
How do you build a portfolio for climate-aware strategies?
Every year the global population emits about 50 billion tonnes of greenhouse gases into the atmosphere. This traps heat and causes further global warming. In line with the Paris Agreement,
we need to bring this number down to zero or even into net negative territory. So we’re asking: “What are the key drivers of greenhouse gas emissions and what specific innovations do we see that help address those causes?” The biggest drivers of emissions fall into a few different categories: electricity and heat, manufacturing, buildings, transportation and agriculture. We look for companies that are aligned to each of these challenges, and that are developing new solutions to address them. We are finding opportunities in renewable energy, such as solar and wind power, electrification and providers of electric vehicles. In the agriculture space, which contributes one-fifth of global emissions, precision agriculture is an exciting innovation that helps farmers water and fertilise the plants in the most efficient way, which mitigates the negative environmental impacts.
What are the key sectors you are diverting capital to so that they can change the world we live in?
One of the big topics that will be addressed at COP26 is the fact that our plans are not aggressive enough to meet the aims of the Paris Agreement. We expect that the investment required to get there is over $100 trillion over the next few decades. Thankfully, we are already seeing support from governments and businesses, as well as changes in behaviour from consumers, which are all contributing to the development of new technologies that can bring down the costs of climate solutions.
And the exciting thing is that the businesses providing solutions may be small start-ups or parts of large conglomorates and exist anywhere in the world. That’s why we use big data and analytics to scan more than 13,000 companies globally to find the most relevant. Fundamental bottom-up research then helps us identify the best candidates for a high conviction portfolio of companies providing the solutions needed to address climate change.
Are there enough places for you to invest in these innovative sectors?
As the ESG Express picks up speed, Jennifer Hill
outlines six key destinations on its route
Where do investment professionals expect it to go next?
omentum behind ESG investing shows no sign of slowing down – quite the opposite, in fact.
‘ESG investing has had a remarkable rise over the past decade and with societal, governmental, regulatory and fiduciary pressures we expect this acceleration to continue,’ said John Yule, head of UK and Ireland at T Rowe Price.
Growth in sustainable investments is set to run for quite a while yet, driven in part by it becoming the default option for investors accessing distribution platforms across Europe
Manuela Sperandeo, BlackRock
1. ESG FACTORS BECOME INTEGRATED INTO ‘STANDARD’ INVESTMENTS
Sustainable investing remains a journey for investors, each taking a different route depending on their preferences and objectives. Once an exercise in excluding those with the worst ESG profiles, investors are increasingly tilting their portfolios towards companies with strong profiles. Now, BlackRock expects ESG integration to become the norm across the investment universe.
‘Sustainable strategies are firmly moving to the core of portfolios as allocation to mainstream exposures, often held for buy-and-hold purposes, are being replaced by sustainable strategies,’ said Manuela Sperandeo, its head of sustainable indexing.
She expects the trend to manifest itself in two ways: firstly, that basic ESG considerations will be integrated into standard benchmarks and portfolios and secondly, that entry level ESG benchmarks will have a higher standard of ESG characteristics and become more climate aware.
‘Growth in sustainable investments is set to run for quite a while yet, driven in part by it becoming the default option for investors accessing distribution platforms across Europe,’ she added.
4. ESG BECOMES A TRULY MULTI-ASSET OPPORTUNITY
While there are improvements in the sustainability credentials of some commodity offerings, there is some way to go for the space to become more widely available to genuinely sustainable investors
Will McIntosh-Whyte, Rathbone Greenbank
‘In 1973, the Collett Dickenson Pearce ad agency gave birth to the slogan “Heineken refreshes the parts that other beers cannot reach”. The same strapline could be applied to ESG investing, which has underpinned a tsunami of thematic fund and ETF launches,’ said Sullivan.
‘Some will prove to be little more than marketing drivel; others will offer investors something far more rewarding.
’Tyndall pairs the Jupiter Ecology fund, which gives broad coverage of themes like the circular economy, water and sustainable agriculture, with Schroder Global Energy Transition, a very focused play on decarbonisation, which it has held since shortly after it launched in December last year.
Granularity in the thematic space allows investors to pinpoint areas of structural growth paired with a compelling story they can relate to clients. ‘Few things help shift units more than a niche story that folk can hang their hat on,’ said Sullivan. ‘In this instance it’s likely
ESG has so far been predominantly an equity story. Increasingly, bond markets are innovating, too. Hans Stoter, global head of core investments at AXA Investment Managers, believes the statement ‘responsible investing equals better investing’ applies to all asset classes.‘
As such, I expect ESG will soon extend to areas that have thus far been slow in incorporating ESG, often citing lack of data coverage, such as private debt and securitisations,’ he said.
From a regional perspective, he expects asset owners in the US and Asia to close the gap on their European, Japanese and Australian counterparts in demanding ESG integration.
‘If the momentum in the most ESG advanced regions is any guide, it will be faster than you think,’ he said.
Rathbone Greenbank applies sustainability criteria across asset classes and carefully considers government bonds (often ruled out on defence grounds) and commodities (often excluded for their environmental impact).
‘While there are improvements in the sustainability credentials of some commodity offerings, there is some way to go for the space to become more widely available to genuinely sustainable investors,’ said Will McIntosh-Whyte, manager of its multi-asset portfolios.
Social bonds play a crucial role
to be along the lines of sustainable food, battery storage and decarbonisation enablers.
’Within sustainable food, Francesco Conte, manager of the JPM Climate Change Solutions fund, points to precision agriculture as an area of growth. Deere & Co, the US-based agricultural and forestry machinery company, is embedding technology that reduces herbicide use and improves planting speed, spraying accuracy and overall farm yields.
Thomas’ ‘themes for now’ include sustainable food, electric vehicles, clean energy, the circular economy and less carbon intensive materials, while his ‘themes for the future’ are artificial intelligence, hydrogen and space.
‘There’s a growing movement among investors to allocate to investment strategies that catalyse real-world change to a more sustainable future, and especially towards a net-zero economic model rather than portfolios that are simply low carbon,’ said portfolio manager Deirdre Cooper.
A low-carbon portfolio is not per se beneficial. For instance, doubling the weighting in three of the largest tech stocks (by nature relatively low carbon) would reduce the carbon intensity of a global equity index by 7%.
‘Doing so won’t affect the vast changes to energy, transport, industry and agriculture required to decarbonise the economy,’
‘Similarly, you could cut your portfolio’s carbon footprint by selling out of emerging markets, where energy systems tend to be more reliant on coal, yet this starves developing-world businesses of capital, hampering emerging markets’ clean-energy transitions.
As ESG extends its reach across and within asset classes, Columbia Threadneedle expects the burgeoning social bond market to play a crucial role in enabling the UK’s transition to a net-zero economy.
Covid-19 proved a powerful catalyst. Social bond issuance totalled $166.6bn in 2020 and stands at $198bn in the year to end-September, data from Bloomberg shows. The UK’s first green gilt raised £10bn in September, making it the largest sovereign green bond on record, having attracted £100bn in bids.
‘Bonds can be far more targeted than equities through “specific use of proceeds” issues that finance ringfenced social, environmental and sustainability projects,’ said Simon Bond, manager of the Threadneedle UK Social Bond fund. ‘Social investing has moved into the mainstream.’
ESG has made it difficult to create a coherent and diverse asset allocation model based on a traditional geographical footprint.
James Sullivan, head of partnerships at Tyndall Investment Management, points to some emerging markets, like Brazil, having significant exposure to fossil fuel companies and state-controlled enterprises.‘
An allocation to a region such as Latin America is fraught with peril through the lens of an ESG adjudicator,’ he said. ‘A more modern approach to asset allocation is becoming more dominant: allocating by industry or sector.
’For Canaccord Genuity Wealth Management, the opportunity set requires a global, thematic mindset rather than a regional, geographical one. ‘Thinking about this opportunity in narrow geographies doesn’t work,’ said Patrick Thomas, its head of ESG portfolio management.
‘An investment in electric vehicles is an investment in cars, batteries, charging infrastructure and rare earths. Some of the most important companies are listed in Japan, but make most of their revenue in China, using technology developed in the US.
‘A better way to frame this is to think about climate transition and more inclusive economic growth as being two distinct macro themes that are probably going to drive exponential return opportunities for the companies that provide solutions.’
2. ESG CHALLENGES THE OLD ASSET ALLOCATION MODEL
3. ESG GIVES RISE TO GRANULARITY IN THE THEMATIC SPACE
These megatrends are creating distinct investment narratives that simply didn’t exist a few years ago.
Legal & General Investment Management expects private real estate and infrastructure to play a bigger role in promoting ESG outcomes from creating sustainable cities to powering the transition to clean energy.
LGIM Real Assets reduced operational energy consumption at an out-of-town office space in Surrey by almost three-quarters by removing gas boilers and installing photovoltaic cells.
‘Now, we see robust evidence that stronger sustainability credentials are linked to higher asset values,’ said Rob Martin, its director of strategy and ESG.
As more focus is placed on the ‘S’ of ESG, real asset investors have also started to measure the social value created by buildings, transport and energy assets.
‘While it’s a good first step, the next step is to take that as a starting point and identify how assets can be managed to drive additional benefits that respond to the needs of different locations – place-based impact,’ added Martin.
Real assets create positive impact
Ninety One sees focus moving from ‘feel good’ to ‘do good’ funds, particularly when it comes to the climate.
5. ESG MOVES FROM FEEL GOOD TO DO GOOD
6. ESG EXTENDS TO ‘GREENING’ COMPANIES
‘To invest in net zero is above all to invest in change, and investors are increasingly looking for opportunities to use their capital in a way that positively impacts the real world.’
It follows from this that ESG investing will become more about ‘greening’ companies instead of simply those that have pivoted towards sustainability or were born sustainable.
While BP is unlikely to be found in many ESG funds, it has committed to cut its oil production and aims to reach 50 gigawatts of renewable energy by 2030 – more than the current renewable capacity in the UK.
‘A good business moves to where the buck is going and BP is doing just that,’ said Sullivan. ‘Investing in greening companies carries the potential of making a palpable contribution towards a more sustainable future while benefiting from a re-rating of the company.
’Lombard Odier Investment Managers believes investors should not avoid sectors like steel, cement or chemicals merely because they are high carbon emitters today.
‘Such sectors will remain economically essential, so instead we must focus on identifying the climate leaders within these sectors with credible plans for decarbonisation,’ said Thomas Hohne-Sparborth, a senior sustainability analyst.
‘Such forward-looking analysis will be vital for investors to adopt.’
Head of ETF Strategy
ESG & Innovation
LYXOR ETF SOCIETE GENERALE GROUP
to promote their commitment to being carbon-neutral or ‘Net Zero’ by 2050. That choice reflects how quickly awareness of climate change has risen among Europeans.
More and more companies, investors, and governments are committing to Net Zero.
TO NET ZERO
s tens of millions of viewers around Europe and the world tuned into the Euro 2020 football competition this summer, their eyes may have picked out a new slogan on the pitch side billboards.
Volkswagen, Europe’s biggest carmaker1 and one of the competition’s sponsors, was using its prime advertising space
Step 1: It all starts with the “carbon budget”
Between 1850-2019, approximately 2390Gt CO2 was emitted.2 To have a roughly 2/3 (67%) chance of keeping warming to 1.5°C, there is around 400-500Gt CO2 left to ‘spend’. Currently, the world emits 42Gt per year – a figure which would use up the remaining amount in 10-15 years.
When you hear someone talk about carbon budget, it really refers to a very simple concept. We have already spent 2,390Gt. We have around 500Gt left to spend. The carbon budget is all about how to spread out that final allowance over time.
IPCC Model Pathway Reference (P2)
If humanity will ever stabilise human-induced global temperature increases, no matter what temperature level is chosen as the maximum, whether it be 2°C or 1.5°C, at some point the planet must reach Net Zero on greenhouse gas emissions. Without Net Zero, global temperatures will keep rising forever.
On average, temperatures today are more than 1°C higher than the preindustrial level. Net Zero has the power to cap the overall increase at a level that causes the minimum amount of climate change. That’s driving what we call “the race to Net Zero” – and to navigate this new world, there are certain important tips to bear in mind.
“Carbon budget” refers to the remaining amount of CO2 emissions that can be emitted globally, beyond which point a given temperature outcome (e.g. above 1.5°C or above 2°C) is ‘locked in’.
Carbon budgets can be accurately calculated because we increasingly understand the correspondence between cumulative emissions and the level of warming.
Why it feels like everyone is going Net Zero
When interpreting a commitment that promises a percentage decrease in emissions by a certain point, a base date is required to make any sense of it. You can say “I will halve my consumption of chocolate” – but do you mean compared to the two bars eaten yesterday, or the 20 bars eaten on this day last month?
Take the example of Lyxor’s Paris-Aligned ETFs. These use a methodology that applies an immediate -50% reduction in GHG emissions in an allocation compared to its parent index (e.g. an S&P 500 Paris-Aligned ETF refers to the S&P 500 index). They then continue to decarbonise from this point at a rate of -7% per year.
Now we must ask ourselves: what is the base year? Lyxor’s Paris-Aligned ETFs are anchored to 2019, meaning they immediately reduce the portfolio’s carbon intensity by 50% from its 2019 level, and continue reducing it further each year.
Step 2: “Base years” make a big difference
If humanity will ever stabilise human-induced global temperature increases, no matter what temperature level is chosen as the maximum, whether it be 2°C or 1.5°C, at some point the planet must reach Net Zero on greenhouse gas emissions. Without Net Zero, global temperatures will keep rising forever
Net Zero commitments are at best trajectories for change over several years. Those trajectories are based on important assumptions,
Step 3: Challenging baked-in assumptions
including the ability to decarbonise at a given pace in future, or the development of effective carbon capture & storage solutions to mitigate emissions.It’s important to be realistic with ourselves about these assumptions. In some cases, the technology that is expected to deliver improved carbon removal, is still in the theoretical or prototype stage. The assumptions can change over time.
None of this is to take anything away from the importance of Net Zero and the great progress that has already been achieved. Lyxor is a firm believer in the urgency of climate change, and we believe that all market participants should feel equipped with the best possible information to make the right choices – including the ability to scrutinise headlines and assess commitments with a clear eye.
Our Guide to Climate Investing was written with this goal in mind, to help investors put the Paris Agreement goals into practice. If you’re ready to join the race to Net Zero, you can find everything you need to know about our range of Climate ETFs on our website.
Net Zero is an extremely positive shift: but it still requires proper scrutiny
How to navigate a new world
of climate commitments
Predicted negative emissions from agriculture, afforestation, and other land use (AFOLU) and Bioenergy with carbon capture and storage (BECCS)
Source: IPCC, SR1.5 Report (Oct. 2018), scenario: Illustrative Pathway P2. Scope: CO2 only, does not include other GHGs.
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M&G Climate Solutions Fund
THE UNGLAMOROUS CIRCULAR ECONOMY COULD SAVE
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It may be a harder sell to investors, but the reuse of waste products is essential to the survival of the planet as we know it
effect, their raw material,’ he said. ‘There are very few other industries where you not only get your raw material free, but someone actually gives you money to take it away. You can already be net cash positive once you’ve got your raw material.’
While Darling Ingredients may seem like an obvious circular economy company, Somel said there are plenty of businesses ‘you would never even really think were circular economy-type companies’. He highlighted Trex, a US maker of decking, which – like Darling Ingredients – travels around the US picking up discarded plastic. ‘They go to supermarkets, they go to industry, picking up people’s rubbish,’ he said. ‘They then convert that plastic into composite floor decking.’
Trex’s main competitor in the market is wood decking, the manufacture of which includes cutting down a tree, chemical treatment, and it only lasts a decade at which point it is thrown away. ‘In Trex’s case, all the raw material is waste plastic. They convert it into composite floor decking that lasts 25 years. It has no requirement for any chemical treatment over that period.’
To finalise the ‘closed-loop system’ inherent in the circular economy, Trex will, after 25 years, pick up the old decking – which they pay the owner for – and it can be recycled into new decking. ‘You can do a side-by-side comparison: wood versus composite floor decking. [The latter produces] more than a third reduction in CO2 emissions.’
Communicating the circular economy to investors is, Somel said, harder than other more obviously green investments. ‘Conceptually, it’s very easy to think about renewable energy,’ he said, with coal plants bellowing out pollution compared with a windfarm.
‘[The circular economy is] not glamourous and, at the same time, you can’t pin down a certain sector. It’s everywhere,’ said Somel. ‘Only by understanding the business do you understand the role they have to play.’
companies reduce, reuse, and recycle in a bid to fight climate change and prevent new products being manufactured.
Somel, the manager of the M&G Climate Solutions fund, said there were two benefits: environmental and financial. ‘We don’t need to mine new material, we don’t need to fabricate, and we don’t need to process. We don’t need to take more vital resources in recreating something that we already have; we can simply use it again.
’From a financial standpoint, he said: ‘It is cheaper to recycle and keep a product in service than it is to recreate it completely from new.’
Saving products from landfill, which generates carbon emissions, is kinder to the environment and has a huge economic impact. Somel pointed to a report by Accenture that predicted if everything that could be recycled was, it would generate a $4.5tn (£3.3tn) saving by 2030.
‘We don’t have the infrastructure to do everything, but it does show the economic potential from a circular economy, never mind the fact that it’s better for the environment at the same time,’ he said. ‘Around 22% of global emissions could directly be cut by not having to mine and fabricate new material, and by stopping this material going to landfill.’
Although the circular economy is an essential part of saving the planet, tapping into this rich seam of opportunity can come with its difficulties. Somel said it is difficult for an investor to identify companies operating in the circular economy as ‘you have to really understand companies and they need to advertise exactly what it is they do’.
he circular economy may not be the most glamourous part of the shift to a greener future, but it is where investors can unearth environmentally friendly gems that are not getting the credit they deserve, according to M&G’s Randeep Somel.
The ‘waste not, want not’ mantra of past generations has been rebranded into the circular economy, which sees
There are very few industries where you not only get your raw material free, but someone actually gives you money to take it away
Randeep Somel, Fund Manager, M&G Climate Solutions Fund
However, the barriers to understanding these firms also mean valuations haven’t ‘really run up’, he said. ‘It’s a beautiful area to find companies that are doing the right thing and not really getting any credit for it.’ These companies are often so hidden that M&G encourages businesses to publish sustainability reports in a bid to promote the work they are doing, Somel said.
To understand whether a company fits into the circular economy, he needs ‘a full lifecycle analysis of the company’, detailing where the product comes from, how it is recycled or reused, and how much energy the process takes up. The process of recycling, particularly metals, is ‘infinite’ as metal can be reused time and again.
Somel highlighted US business Darling Ingredients as a great example of a circular economy company, which he said has a ‘brilliant distribution model’. The company picks up used cooking oil and meat from abattoirs and butchers, taking carcasses from 122,000 different distribution points across the US. It then processes the used products into a sustainable fuel.
‘They get paid for taking away other people’s trash and it is, in
Around 22% of global emissions could be cut by not mining and fabricating new material, and by stopping this material going to landfill
Randeep Somel, Fund Manager,
M&G Climate Solutions Fund
The geopolitical theme of energy security and stability is a megatrend
that will dominate geopolitics for decades to come
decades, as Frederik Kooij, CIO of Tribe Impact Capital points out. ‘The reason we are seeing such incredible volatility in fossil fuel prices right now is the disparity between the haves and the have-nots: the biggest, among the latter group, is certainly China, but much of Europe and the UK also need to increase self-sufficiency in energy terms,’ he said.
Tribe’s chief impact officer Amy Clarke notes that this effect is leading to a growing focus on community energy and more localised grid infrastructures in the UK.
‘There’s a growing understanding that we can increase energy security by decentralising it and, as in emerging economies, creating microgrids that are more self-sufficient, for smaller communities. The advantage is first that it’s not subject to the ebbs and flows – as well as risks – of a big national infrastructure, but also it enables more flexible pricing strategies that help tackle fuel poverty because prices are not necessarily dictated by wholesale markets,’ she said.
ENERGY SECURITY TAKES CENTRE STAGE
nvironmental factors are now entrenched in investors’ portfolios and look set to become mainstream. But as the dynamic process of energy transition moves ahead and broadens, new areas and approaches are appearing on the radar.
The vast geopolitical theme of energy security and stability is a megatrend that will dominate geopolitics over the coming
You can’t address climate change in a realistic way without making sure the basic needs of developing nations are being met
Louisiana Salge, EQ Investors
Carbon credit markets
There is a growing understanding at a company level that the food production system is broken, Clarke believes. ‘We’ve seen some ETFs launched in this space, and at a single stock level when we come across companies that are stewarding the land better and are creating much more nutritious food, we consider them more “future fit” if that narrative is embedded and reflected in terms of where they’re making their money and the intentionality of the management. We have confidence that this is the type of business that’s going to thrive in future.
‘We take a long term perspective on all of our investments and this secular theme is one that underpins the way we look at the world,’ she said.
Outside of reducing harmful emissions, one of the most direct strategies is carbon offsetting, which allows businesses in all sectors to buy permits or carbon credits generated by green projects to compensate for their own harmful emissions.
The largest and most developed carbon credit market, the EU Allowances (EUA) has seen the price hit record levels recently,
Among different ways to invest in the carbon credit market, she cites WisdomTree’s Carbon ETF, which reflects the price movement of the ICE Carbon Emission Allowances futures contract, and SparkChange, a technology platform headed up by Daniel Barry, former global head of BP’s environmental markets division.
‘One of the more interesting carbon credit investing vehicles I’ve seen recently is Respira, which creates capital market solutions to enable long-term partnerships and align the interests of carbon offset project developers, buyers and capital providers. The portfolio is managed by Chris Villiers, who was previously head of energy investment at Guinness Asset Management.’ While the business currently runs an SPV, it may consider launching an investment trust in future.
Looking to the future, with the Taskforce on Nature-related Financial Disclosures (TNFD) widely expected to follow the same path as TCFD (Task Force on Climate-Related Financial Disclosures) in terms of greater adoption and possibly mandatory enforcement, Jordan believes that biodiversity credits might become a reality.
‘It will be harder to find a set of metrics to assess these because there are so many inputs, for example water waste and land usage, but work is ongoing in this area,’ she said. At present around 90% of financing in this area comes from governments, so there is huge scope for the capital markets to play their part, she noted.
Another area with scope to develop, Jordan says, is the concept of Just Transition, or the need to manage the social effects stemming from the energy transition: the secretariat of the UN Framework Convention on Climate Change has identified 1.47 billion jobs in sectors critical to climate stability, and just transition means understanding the implications for those workers as they switch to lower-emitting methods.
touching €60 per tonne having traded in a historic range of around €30 per tonne over recent years. This is partly due to the significant influx of investors into the market: ICE Futures reported in June that since 2017 the number of participants trading ICE’s carbon markets has increased by more than 40%, with the number of North American participants jumping by more than 70%.
While futures are one way to invest, Paris Jordan, multi-asset analyst at Waverton, points out that there are a growing number of options for investors in this space and that some have different benefits. Those who buy and hold physical credits are effectively cutting the supply available to the market, forcing the price up which means emitting companies, particularly those with the largest footprints, are faced with high permit costs, a strong incentive to reduce their own emissions, she noted.
Jordan highlights Abbie Llewellyn-Waters, head of sustainable investing at Jupiter, as a manager with a strong awareness of the problem and a holistic investing style that aims to engineer greater inclusivity as the transition moves ahead.
Also falling under the broad remit of a more inclusive model of sustainability is the growth in emerging market green bond issuance.
‘This is a very interesting area because the biggest energy transitions need to happen in emerging markets. So we’re excited to be supporting both corporate and government green bonds as well as development banks, which form a vital on-the-ground presence,’ said Louisiana Salge, impact analyst at EQ Investors.
‘This is very much aligned with the idea of Just Transition because it enables the development of services that can be lacking in these countries while at the same time not locking them into the carbon-intensive business models that we have.’
Another area of interest for Tribe is biodiversity, as seen through the lens of agriculture. ‘This can be boiled down to soil: the way that we work with soils and the way we farm generally has a massive impact on the biodiversity within soil, and it also relates to climate because soil is a massive carbon sink,’ said Clarke.
‘So I think we’re starting to see more of a recognition that we need a different type of agriculture to move forward, shifting away from mono-culture type farms that grow one crop across huge landscapes with no natural barriers or breaks, to a notion of regenerative agriculture that really works with the soil. This can not only increase soil’s capacity to store carbon, but also works with broader nature to increase biodiversity and, of course, increases human health by growing more nutritious food.’
EU ALLOWANCES FUTURES PRICES (US$)
EQ has only recently begun to invest in this area, via the Amundi Emerging Market Green Bond fund, because issuance in the market has now picked up to the point that it is possible to create a diversified fund with daily liquidity. ‘The reason we didn’t invest in this area earlier is that the universe was not sufficiently developed, but we are very excited to be a part of its progress now,’ she said.
Salge also believes that real impact investing is a holistic process and can’t just consider climate factors in isolation. ‘The reason there are 17 UN SDGs is because there are so many issues and they’re all inter-linked.
‘Impact investing as we see it is about taking a more inclusive lens to all of the environmental and social challenges we are facing: you can’t be addressing climate change in a realistic way without making sure that, for example, the basic needs of developing nations are being met,’ she said.
THE WHAT, WHERE AND HOW OF
Impact investing provides funding to companies and bond issuers actively addressing the world’s major social or environmental challenges. Impact investors like us intentionally direct capital with the aim of generating positive outcomes for people and the planet while seeking to deliver competitive investment returns.
We focus our research on 11 impact themes, centred on life essentials, human empowerment and the environment. Life essentials covers affordable housing, clean water and sanitation, health and sustainable agriculture. Human empowerment seeks to address the digital divide, education and job training and financial inclusion as well as safety and security. The environmental category encompasses alternative energy, resource efficiency and resource stewardship.
To be considered for our impact funds, each potential investment must meet a high bar of alignment with our impact themes. The impact case must be material, with the majority of a company’s revenues or business activities advancing one or more of our themes. The impact of the potential investment must also be additional, addressing a specific need that is unlikely to be met by other agents, be it competitors, governments or non-governmental organisations.
We believe it is also important to understand a company’s or an issuer’s holistic impact. For example, with green bonds, we scrutinise not just the use the bond’s proceeds will be put to, but also the issuer’s wider business activities. With government bonds, we only invest where the proceeds are being used specifically to address one or more of our impact themes. We also assess any potential investment for unintended negative consequences that would outweigh its positive impact — for instance, the impact of a new recycling facility on local communities or the environmental implications associated with the data storage involved in digital solutions.
Finally, the impact case for each investment must be measurable so that we can quantify and report on its progress over time. We believe investors must be able to analyse, track and measure impact outcomes as thoroughly as they do financial outcomes. We also believe this transparency helps encourage much-needed capital to be directed towards impact companies and issuers.
To measure impact, we create custom key performance indicators (KPIs) for each company or issuer in our portfolios. The KPIs will vary depending on the security, sector or impact theme, but they must all be logical, transparent and based on reliable information, such as science-based insights from our climate research team.
For example, we may measure the amount of greenhouse gas emissions avoided by recycling waste instead of sending it to landfills or the percentage of a population provided with clean water, internet access or affordable housing. In addition to monthly publications on our funds’ financial performance, we publish annual reports on KPIs and the impact of our holdings.
When the United Nations (UN) published its Sustainable Development Goals (SDGs) in late 2015, we were pleased to see how well our themes aligned. Today, between our impact equity and bond approaches, our investments address all 17 SDGs, either directly or indirectly.
For each company and issuer in our portfolios, we tag the goals that we believe they align with, as well as any of the 169 underlying targets outlined by the UN. While we do not manage the portfolios to a targeted level of alignment, our high standards for inclusion result in an investment strategy that naturally supports many of the SDGs. All the companies and issuers we invest in offer what we consider to be much-needed solutions to many of the major challenges identified in the SDGs. Wellington is proud to continue supporting the UN SDGs.
Both equities and bonds provide excellent opportunities for impact investing, with large and growing opportunity sets. In fact, we believe the two asset classes provide complementary impact exposures and can be blended within a broader portfolio to create compelling synergies. Some themes are easier to access for fixed income managers, such as affordable housing bonds issued by local housing associations. Other themes, such as financial and digital inclusion, are more accessible for equity managers.
We believe impact investing does not entail giving up return potential. Both the Wellington Global Impact Fund and the Wellington Global Impact Bond Fund aim to deliver competitive returns for clients alongside positive social and environmental outcomes. All our impact investments must meet specific financial thresholds to be considered for inclusion in our portfolios. In our view, many of the companies we target also benefit from structural tailwinds given their focus on products and services that seek to address some of the world’s most pressing issues. Companies that can provide effective solutions to those problems are likely to see healthy growth in their revenue and market share in the years to come.
After defining the universe of potential investments that meet our impact criteria, we focus on selecting the best combination of securities to reach our financial objectives, via bottom-up research. Key to successfully building and managing portfolios, in our view, is our multi-disciplinary approach. We regularly integrate the insights and perspectives provided by Wellington’s global teams of experienced research professionals across industries, asset classes and investment styles. This includes close collaboration with our career credit analysts and industry specialists, who provide detailed insights at the security, industry and sector level. We also draw heavily on the expertise of our dedicated ESG research and climate research teams.
We seek to enhance both the impact and the financial value of our portfolios further through active engagement with company management teams and boards. Engagement helps us identify opportunities for companies to improve, measure and report on their impact activities. It also allows us to report more meaningful data at the issuer and portfolio level. Ultimately, engagement creates an important feedback loop and mechanism to help us deliver and measure impact.
Impact investing is an exciting space where we get to help clients align their financial objectives with social and environmental aspirations. We are committed to helping investors appreciate the potential benefits of directing their equity and fixed income allocations towards solutions that help people and the planet while pursuing their investment goals.
CFA, Fixed Income Portfolio Manager
What is impact investing?
Where do you find impact investment opportunities?
How do you define a company as “impact”?
How exactly do you measure impact?
How do you address the UN SDGS?
Which asset class is most suited to impact investing: equities or bonds?
What about financial returns?
How do you bring it all together?
How do you approach engagement?
What is so attractive about impact investing?
For more information, please visit: wellingtonfunds.com/sustainable-investing
Sustainable agriculture and nutrition
Clean water and sanitation
Wellington’s impact portfolio managers, Campe Goodman and Tara Stilwell, answer essential questions on impact investing and how to access it.
Education and job training
Safety and security
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