The idea of socially responsible investing (SRI) has been around at least since the 18th century when, in the US, the Quakers prohibited members from investing in the slave trade.
Other religious leaders discouraged the ownership of shares in industries that either harmed their workers or were perceived as immoral – tobacco, alcohol, firearms.
In more recent times, worries about climate change have added a whole new swathe of sectors – high carbon ones – to the list of potential ‘unethical’ investments. And we have seen the birth of a new type of SRI investor: the pragmatist who believes companies that adopt good environmental, social and corporate governance (ESG) practices will tend to do better in the long term.
For whatever reason, interest in money managed according to these principles has been growing non-stop. To discuss the latest implications for both investors and product providers of this trend, we gathered some top fund buyers and fund managers specialising in this area and a highly-regarded consultant in one of the most SRI-focused countries in the world: Sweden.
It is the same for AP1, one of the five buffer funds in the Swedish national pension system. AP1 managers have been looking at SRI issues for 15 years, according to Nadine Viel Lamare, head of sustainable value creation. Last year, they formulated an overall sustainability strategy.
“We were really afraid that the exclusion route would affect returns. So that is why we started the engagement path” – Nadine Viel Lamare
“We want to focus on resource efficiency, and that defines responsible ways to use natural resources, human capital and financial capital,” says Viel Lamare.
“I am responsible for pushing our internal managers but we also have 40% external managers, so I am pushing them. And then I engage with companies, so I try to push them also. I am the great pusher.
“SRI is becoming more and more important,” says SEB head of fund selection Mikael Haglund.
“Pressure is coming from both the retail and institutional sides – we see growing interest in both those channels for SRI and climate change as well – and that is something we respond to.”
Tove Bångstad is currently head of Nordics for Amundi Asset Management but earlier in her career she was responsibly for setting up the first ethical funds for institutional clients at SEB.
Before that, she was chief financial officer of the Swedish Heart and Lung Foundation, where ESG is a high priority.
“What I can see is that institutional investors now focus much more on ESG, says Bångstad.
“If I look back 10 years there were just a couple of our clients that looked into ESG but today it is almost everyone – both institutional investors and wholesale fund selectors.”
As a result, Amundi made the decision to incorporate SRI and ESG throughout its investment management process. “Active managers cannot invest incompanies that have the lowest ratings,” she explains.
But what is driving the more recent surge of interest in SRI? Our survey of Swedish fund selectors was telling. Firstly, 75% think that SRI considerations improve long-term performance. But almost 70% would be prepared to tolerate a small amount of underperformance if it were caused by following SRI principles.
And some 60% of respondents thought that the main driving force behind the move to more SRI was not their clients demanding it, and certainly not government regulation, but the power of public opinion. Companies, whether they are retail brands or pension funds, do not want to be associated with what are seen as unethical practices.
So we cannot divide the world neatly into those who adopt SRI for ethical reasons and those who adopt it for pragmatic reasons. “I think that there is a mix of two completely different things,” says Ulrika Hasselgren, managing director of ISS-Ethix, who advises institutional investors on their SRI strategy.
“The struggle is that in one pot we are talking about what is called in some markets SRI, in others ethical investing. There is a whole challenge of definitions.“
Some institutions do not have ethical values but they have external pressure – from their boards or their investors. Others, like the Church of Sweden, have those values. It is difficult for fund managers to understand what all the different investors want.
Often investors themselves do not know what they want until they hear what you have to say, then they say ‘Oh yes, I want that’.”
According to Susanne Bolin Gärtner, head of fund selection at Folksam, the biggest insurance company in Sweden, the situation is changing rapidly.
“We used to say that we guide on three parameters: performance, low fees and sustainability,” she says.
“That was a couple of years ago. But now we need a hygiene factor, which requires us to go through the holdings of all our funds. The most important thing for me is to have transparency so we can show our end clients the sustainability profile of their portfolios.“
“We work with the fund managers to get them engaged. Whereas before we would say ‘We cannot be responsible for the entire portfolio of all our external funds’, now if a journalist rings up and asks if a particular company is in your portfolio, we have to know. So we work much more closely with external managers.”
You might think that it would be very resource intensive to look through every fund’s holdings – but according to Susanne, Solvency 2 has forced the issue – you have to look at all holdings anyway. The other complexity is that it is not clear what kind of behaviour counts as unacceptable, especially when it comes to suppliers.
“Sometimes it is not black or white,” says Bolin Gärtner. “You might have once excluded a company that is now okay. You work in different time frames. It is dangerous to simplify things. The important thing is to understand the underlying holdings.” Haglund is in the same position.
Ethics and engagement
“We have moved towards a process where we screen our holdings,” he says. “And on the external funds we have a process where we demand that they follow the United Nations’ Principles of Responsible Investment (PRI).”
Following PRI might give you generally agreed guidelines on how to judge the behaviour of companies, but it does not deal with how SRI effects performance and whether you should avoid troublesome sectors or actively engage with them. Viel Lamare explains how these considerations have changed over time.
“In the late ’90s, people really thought there was a trade-off between being sustainable and getting good returns,” she says. “As a long-term investor, we do not see that conflict of interest. But in the short-term, there can be. What we had to do is decide what does this mean for a public pension fund in Sweden and we had said that the minimum level is that we want all the companies that we invest in to comply with international conventions that Sweden has signed. Then we said we do not want to exclude the companies that don’t comply – we engage instead, to try to make them change.”
When AP1 made their first screen back in 2002-03, 10% of market cap ended up in the bad box, especially in the energy sector. “We asked ourselves: can we exclude 10% of market cap without being afraid that this affects returns?”
“At the time, exclusion was the only way that things were done in this sector – greenscreens might be light or dark green but they were binary – either the investment passed the screen or it did not. We were really afraid that the exclusion route would affect returns,” says Viel Lamare. “So that is why we started the engagement path.”
This allowed AP1 to invest in the highest performance sectors, as long as the companies were engaged in reform. That way you can follow SRI-principles and still be a high performer. “But the key word is high, not highest performer,” points out Hasselgren.
For bond investors, the situation is different, according to David Averre, head of credit research at Insight Investment. “The initial pressure from clients was ‘Are you a signatory to the PRI?’” he explains. “Increasingly, though, clients are asking more questions. Obviously, they have formulated policies on the equity side and now they are thinking more about the fixed-income side. They are often trying to take policies from equities and super-imposing them onto fixed income, which is clearly different because we have a different level of engagement and influence. Integrating ESG into the fixed income research process has to be practical.”
This is especially the case with the biggest issuers – countries, for example. “If you are not comfortable with, for instance, the US government, then you have cut yourself out of a big section of the bond market. And it is tricky to engage with governments. There are parts of the fixed income market where you can have influence – but government bonds is not one of them.”
There are some emerging market governments that clearly don’t act in responsible ways, environmentally, socially and financially. So how does Averre invest in the fixed-income emerging markets?
“You are probably investing in emerging markets on the basis that you want to take the risks that you are running there anyway,” he says. “Sure, you might want to engage with some policymakers, but you are probably investing there because you are getting paid a lot more than from western governments. All clients are torn between sustainability and SRI on the one hand, and the fiduciary duty to maximise returns on the other.”
Sebastien Thevoux-Chabuel is an ESG specialist and fund manager at Comgest. He says the complexity of the situation requires end-clients to be clear on what they want. “There are three dimensions – an ethical approach, a corporate social responsibility approach and then the long-term outperformance approach. If you do not know which of these you want, it will be hard to achieve.”
There are basic contradictions, according to Thevoux-Chabuel: “For instance, you think that a company with ethical issues might in the long term end up having problems – but the long-term can be so long that it will kill you in the meantime.”
On the ethical side, there are always going to be grey areas where investors quite reasonably disagree with each other. His solution? Let the clients choose – each can have their own tailored approach. Of course, that only works with segregated mandates, which luckily is a big part of Comgest’s business.
Why do it?
This is what comes down to: whether you are a fund manager or an investor, you have to make sure you are clear why you are interested in SRI and what your time horizon is. Simon Webber is the lead portfolio manager on Schroders’ global and international equities team. He also manages the Climate Change fund. And climate change – like good corporate governance – is an area where there is a clear convergence of ethical and pragmatic interests.
“We think of the reasons for doing what we do – a proper integration of ESG – helps adds value to clients,” he says. “Screening is easy. What is not easy – where there is more potential for generating alpha in our opinion – is doing your own research into the quality of a company, how it is run and managed. The longer your investment horizon, the more this matters. If you are a high-frequency trader, you do not care about it because the risk of an event happening while you own the stock is infinitesimal when considering the holding period. But when you are owning stocks for five years, you are investing in the company, not only the stock. Companies with a really bad ESG performance are littered among the worst performers in global equites.”
Webber is clearly happy to have resolved the dilemma of performance vs ethics – he has developed a specific set of criteria he cares about and a time horizon to allow him to make practical investment decisions. Now it is up to the rest of us to do the same.
Source: Portfolio Adviser