How investors can invest responsibly across asset classesResponsible investment 23 April 2018
In recent years a proliferation of new options, reflecting a maturing of the market, has ensured an RI approach can be applied to every asset class. There are variations on the levels of RI - screening, integration and impact investing, which are available across equities, fixed income, alternatives and real estate. Each can be adapted to the depth and profile of a particular investment mandate. The ability to apply different RI approaches across asset classes has come about as the level of sophistication in environmental, social and governance (ESG) analytical tools has advanced.
Equity investing has been given a powerful boost through the increasing effectiveness of ESG scoring for both screening and integration approaches.The first is used to exclude exposures that conflict with investors’ principles, while ESG integration uses scoring for a nuanced assessment of how well a company is, or isn’t, embracing important indicators of potential value creation or erosion.
Ultimately, ESG scoring provides material information on risk and opportunity required for long term investment decisions - something which is particularly important for active managers.
To make conviction decisions, fundamental analysis needs to focus on the ability of a company to generate sustainable gains over the long-term. By using our proprietary analysis that flags potential sustainable opportunities to add value, as well as incorporating controls, which aim to reduce unnecessary investment risk, equity strategies can integrate ESG considerations into the investment decision.
Forming a critical part of fund managers’ decision-making on equities is the interaction with companies on key themes through voting at corporate meetings and other engagement with companies
An example of this might be in the area of carbon foot printing, where an ongoing dialogue with a company might determine whether it is taking the appropriate course of action to lower its footprint. Failure to do so might result in divestment of the stock in anticipation of share value erosion.
The extent of engagement an investment manager has with a company comes into particular focus when applied to impact investments in public markets. Impact investing targets positive societal change, and at the same time, looks to deliver specific financial returns. The ability to apply an impact approach in public equity markets has only started to take shape.
The impact investing demands of delivering specific, intentional positive societal outcomes – above what would have ordinarily taken place – are more difficult to prove when buying a stock in the secondary market. However, we believe there are certainly ways that impact investing can be applied in public equities.
For example companies which deliver positive outcomes through their products and services, such as low cost medicines or access to affordable education, can be deemed to be making a positive societal impact. But care and due diligence on behalf of the investment manager to record the intentionality of these investments is crucial and demonstrate the positive contributions made by the investments in addressing the specified social or environmental concerns.
Growing pressure to address the 17 UN Sustainable Development Goals, contained in the 2030 Agenda for Sustainable Development, will have a major effect on the development of the impact investing market in public equities. Aimed to align investor interests with areas of vital social and environmental significance such as eradicating poverty, improving access to healthcare and tackling the impact of climate change, these goals are laudable and have gained much attention. Public equities offer a huge opportunity to ‘move the needle’ in this respect, but careful analysis is required to identify and record the genuine and intentional impact outcomes.
When it comes to fixed income, credit analysts and fund managers are sensitive to market uncertainties as they aim to preserve capital and identify all sources of potential downside risk. In this respect, RI issues contain material financial information which affect the credit quality of an issuer.
ESG criteria effectively adds a layer of additional qualitative information. Fund managers can incorporate this information into their decision, taking account of both risks and opportunities, and apply them to their fixed income portfolios.
One of the most powerful demonstrations of RI in the bond space has been the rapidly-growing green bonds market, which is expected to be worth $350bn this year.*
Green bonds enable investments in transparent projects with environmental benefits, a natural source of capital to support energy efficiency, renewable energy and other projects related to climate change adaptation and mitigation.
Particularly unique to the green bonds is the fact that the use of all proceeds must be identified up front. This means the ability to measure both the specific positive environmental impact, as well as the financial return, is much more transparent.
This is a very attractive feature for investors looking for an impact investment through public debt markets. The implementation and global adherence to the Green Bond Principles will add further comfort in the avoidance of ‘green- washing’ in this area.
Private market investing has greater control over individual investments, lending itself to impact investing - which focuses on financing businesses and projects designed to have intentional, positive and measurable impacts on society, while simultaneously delivering financial market returns. That’s because bespoke measurement and reporting is more effective in delivering the dual goals of financial and societal impacts.
Investing using alternative strategies including private equity, private debt investments allows greater visibility and control in directing the investment to a specific cause as the capital raised from investors is channelled towards an investable solution that is tailored to directly address the impact challenge.
For example, to address the need for quality education and improved employment outcomes to low income populations, Andela, a talent accelerator provides software training including coding skills training to talented young people in Kenya and Nigeria. The beneficiaries are provided with an income whilst training ensuring that income is not a barrier to accessing this benefit. The impact outcomes from this investment are clear - smart young people in the relevant markets are able to develop their skills and improve employability with the company’s graduates earning 300% more than the average for Nigerian graduates, with women making up a fifth of graduates compared to the Nigerian average of 3% to 4%.** Channelling funds through the private market allows for greater precision in the intended impact, and more flexibility as well as detail in measuring and recording the financial and societal outcomes.
As the social impact is fully embedded into the business model, there is no trade-off between impact returns and the financial returns. Impact investing harnesses the power of capital towards solving ‘real issues’ facing society. It is about steering the power of capital towards greater utility.
In real estate, a significant number of initiatives and certifications are moving investors and developers towards greener and more sustainable buildings. The likelihood is that over time, investors will increasingly favour buildings with strong sustainability performance, which certification recognises and leads to market standard.
Asset managers are able to assess the certification potential of the properties they manage, carry out ESG ratings and put in place detailed action plans to improve performance. They are also able to track energy, water, and waste using the ESG tool and calculate ESG footprints.
As a result, it could be argued that applying ESG analysis to real estate portfolios can have significant commercial benefits over the longer term. At AXA IM we have committed to have 75% of our real estate assets under management accredited with internationally recognised ‘green’ certifications by 2030.
We can see there are powerful RI options across all asset classes. The various offers are nuanced to address how fund managers can have a different read on ESG factors, meaning every approach can be catered for.
Ultimately, the environment now exists for investors to understand the ESG risk and opportunity across every asset class. We have entered a new paradigm where investors can potentially have the returns they seek, while at the same time shaping a better world.
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