Schroders believes sustainable investing is all about allocating capital for the future.
As Environmental, Social and Corporate Governance (ESG) moves up investors’ agenda, there is a growing trend in the industry towards products that track a sustainability index.
But Jessica Ground, Global Head of Stewardship at Schroders, thinks an active approach is needed to capture the benefits of ESG investing.
She explains that ESG investing is incredibly complex, for example, incorporating climate change into an investment strategy has many different aspects ranging from governments’ responses to climate change, to how consumers may modify their own behaviour.
“It is very hard to do this passively,” she says.
Ms. Ground thinks another issue with ESG indexes is that they tend to be quite backwards looking, based on historic data.
“ESG is really about navigating future forward change. It can’t necessarily be distilled in a passive approach,” she says.
She also points out that while the quality of ESG data is improving, it is still not systematically at the same level as other investment data, for example 40% of carbon data is estimated.
“Some of the passive strategies have been low carbon strategies. But if you have a passive approach on imperfect information, it is not a great outcome,” she says.
By contrast, Schroders takes a very active approach to its ESG investment process.
Holding companies to account
Ms. Ground explains that while around 8.6% of the assets the group manages have some kind of ethical exclusion, such as not putting money into tobacco companies, Schroders has 20-plus years of firm-wide experience of ESG integration, and this is the investment strategy it pursues for the vast majority of its clients.
“We see our job as allocating capital for the future and we really believe that in doing that we need to understand how the world is going to change.
“ESG provides us with tools that help us think about the future and it helps us assess which companies are best placed to navigate that,” she says.
Schroders has 11 dedicated ESG specialists, who work with more than 200 equity and credit analysts across its global locations2.
Ms. Ground says such an approach can definitely generate alpha.
Schroder’s ESG strategy goes further than just picking companies that look likely to benefit from future changes.
“The other area of ESG that is very important to us is the idea of holding companies to account,” Ms. Ground says.
“We as shareholders can engage companies to get improvements, and we have a really powerful seat at the table to get change on ESG issues.”
In fact, Schroders had more than 760 engagements with companies in 2016 alone, while it voted in more than 5,160 company meetings during the year.
Nor does Ms. Ground think investors have to sacrifice performance for their principles.
“There is a great body of academic evidence that looks at this issue. Companies that have good governance tend to have much more resilient operational performance in the profits,” she says.
“What is interesting is that also gets recognised by the capital markets, so they have lower costs of debt borrowing and equity.”
Sustainability as risk management
Responsible investing can also be a good tool for managing risk and safeguarding investments.
Ms. Ground gives the example of a piece of research carried out by Schroders in which three catalysts are identified that could result in sugar causing Big Food to become the next Big Tobacco.
She points out that over consumption of sugar is leading to obesity, heart disease and diabetes. There is a rising awareness of this issue among consumers and governments, which creates an ongoing headwind for companies.
As a result, these firms could face lower sales growth and pressure on profit margins as they have to increase research and development investment.
But certain firms, such as those that have already invested heavily in R&D and implemented nutritional profiling across their product portfolio, are better placed to increase their market share and become market leaders.
Ms. Ground says: “Through the research, we really identified winners and losers, with some companies already addressing the issue, but other companies lagging.”
The research also looked at the fact that sugar in the US is labelled in more than 40 different ways, and given that the US is a litigious society and has an obesity problem, there were likely to be legal cases against food companies.
Ms. Ground says that when accounting for potential litigation costs, lower sales growth and increased research and development investment, the impact on financials over the medium-term could be material.
“We identified a different risk. The first aspect, talking about declining consumption and margin trends, appealed to our equity investors, but the previously unidentified litigation risk appealed to our debt investors, who were able to position portfolios around it.
“You can see from that initial work there are multiple ways that we can generate alpha from this.”
Ms. Ground points out that realistically, with more than half a trillion dollars of assets under management worldwide, Schroders was always going to have some exposure to issues such as the one relating to sugar.
But on the back of the research it has organised round tables with companies to discuss the issue and how they might disclose better on the sugar content in their portfolios, and make progress on the issue.
“We can really start to monitor and make sure they are doing something and taking it seriously,” she says.
“It is about managing these risks in a way that can benefit portfolios.”
What gets monitored gets managed
Ms. Ground advises companies that want to score highly on the sustainability front to focus on the material issues for their company.
“What are the most important stakeholder relationships and how can you get them on to a sustainable footing.
“Make sure you are forward looking and really thinking about how our world is changing, and moving ahead of that.”
“We know people are taking them seriously when they also put KPIs around them and monitor them.
“It is the adage what gets monitored gets managed,” she says.
But Ms. Ground adds that the targets had to make sense for the business.
“If you are an oil and gas company are you monitoring your carbon emissions and expecting carbon to get taxed?
“That is incredibly important and there is a real difference to saying we care about the environment, and this is how we are reducing our carbon footprint,” she says.
Endowments lead the way
Schroders has found that globally ESG is particularly high up the agenda of endowments.
“We see endowments leading the way and a lot of them really wanting to align their mission with how they are investing. They see their investments as an extension of this,” Ms. Ground says.
Many sovereign wealth funds also place an emphasis on ESG as they think about the long-term sustainability of the world as major asset owners, while there is also increasing interest from pension funds.
Ms. Ground explains that this interest comes from the fact that younger investors feel very strongly about sustainability issues and ask more questions about them.
At the same time, millennials are starting to work in pension funds themselves and they are focused on creating change.
Growing opportunities in Asia
Ms. Ground says data showed there was also a high interest in ESG investing in Asia, particularly among young people.
A global survey found that 59% of millennials in Asia thought the issue of climate change was very pressing, compared with just 30% in North America.
“I wouldn’t be surprised if Asia leap frogged other regions in terms of ESG investing,” Ms. Ground says.
“Asia has less history in this area but because things are changing so quickly, they can start with a more innovative approach, not just having polices but setting targets and measuring things.”
She adds that policymakers in Asia were encouraging engagement with ESG issues, and there was a rise of stewardship codes in Taiwan, Singapore and Hong Kong.
Ms. Ground thinks Asia is also well positioned to learn from the mistakes of other regions.
She says in Europe there have been cases of green washing, where companies had put ESG policies in place but not really done anything else.
In other cases, investors had excluded coal companies from their portfolios, but this had not actually led to a reduction in the number of coal mines in operation.
She says: “Let’s learn from the mistakes and move away from the green washing and just look at how as a pension fund you can really invest in a more sustainable way, and how as a business owner you can create a really long term sustainable business that is going to last.
“There is a ground swell of opportunity.”
Chris Durack, Chief Executive Officer, Hong Kong & Head of Institutional Business, Asia Pacific, at Schroders, says: “As an active fund manager committed to fundamental research we have the benefit of understanding that companies’ futures are intrinsically linked to the environment in which they operate.”
“We are looking to use our combined resources and experience to gain better insights from how we link a view of social and environmental change to company analysis and investment decisions.”
“While parts of the industry are still asking whether ESG factors can affect performance, we have moved forward and are focusing on how to define and measure ESG factors to maximise their benefit for our clients.”
1 Rating for overall approach to responsible investment in the PRI 2016 assessment
2 Data as at March 31, 2017
Important Information
This document is intended to be for information purposes only and does not constitute any solicitation and offering of investment products. Investment involves risks. This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.
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