Overcoming barriers and capturing opportunities in sustainable investing

THE looming climate crisis has spurred investors and fund managers to shift their focus towards investments that can address climate-related risks.

But Liew Tzu Mi, GIC chief investment officer for fixed income and chair of the sovereign wealth fund's sustainability committee, said there is still much to learn and improve upon in this fast-evolving space.

"We must continue to adapt our sustainability engagement strategies, improve our tools and processes, and provide continuous training to our analysts and portfolio managers," said Liew.

ESG buzz

Environmental, social and governance (ESG) factors have shifted up the agendas of many companies amid rising regulatory pressure and increased demands for climate-related risks disclosures.

"Businesses are finding out that taking care of multiple stakeholders, beyond the core profit motive, is sometimes just good business, including the way they treat their employees, hire diverse teams, put together an independent board of directors," said Liew.

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Governments too have started to impose more regulations on ESG issues. Some businesses may have to pay an explicit price for carbon emissions through taxes or cap-and-trade regimes, for example.

Meanwhile, a new generation of consumers is demanding solutions to address the climate emergency. Some are, for instance, opting for alternative sources of protein or voluntarily paying for carbon offsets when they get on a flight.

As financial markets become increasingly concerned about climate risks, Liew said there has been a wave of new ESG instruments and products.

"While still in the emerging phase, commercial financial market solutions addressing ESG issues will likely become more scalable and investable for large asset owners over time."

A growing class of financial market solutions is green financing, which GIC has tapped for its own investments.

For instance, GIC is working with UOB on green financing for an office asset in Australia.

"UOB is pleased to have the opportunity to work closely with GIC in the integration of sustainability into its portfolio, investment processes, business operations and corporate culture," said Lim Lay Wah, who heads the financial institutions group at UOB.

"GIC is a long-term investor and we look forward to continuing our global collaboration with them in investing and forging a sustainable future together."

Data-led insights across teams

GIC has developed a set of climate scenarios to stress-test its portfolios and quantify the impact along different dimensions, including asset class, geography and industry.

With these insights, investment teams can delve into where vulnerabilities lie and find ways to strengthen portfolios.

Investment teams are also equipped with a range of data and analytical tools to assess the impact of climate change.

GIC's climate value-at-risk dashboard, for instance, shows how the cash flows and valuations of listed companies would be affected by factors such as carbon prices or physical risks.

"We have training sessions for our analysts and portfolio managers on these tools, and more broadly on how ESG issues could affect their investment portfolio," said Liew.

Analysts are also encouraged to share insights across traditional asset classes, given that sustainability cuts across equities, fixed income and private markets.

"The knowledge that our infrastructure team has gained from investing in electric vehicle charging infrastructure, for example, has benefited our equities teams in their evaluation of automotive companies and electric vehicle makers," said Liew.

Incorporating sustainability

Given the mounting pressure for companies to address climate change and its risks, sustainability is integral to GIC's mandate to preserve and enhance the international purchasing power of the reserves under its management.

"We believe that companies with strong sustainability practices will offer prospects of better risk-adjusted investment returns over the long term, and that this relationship will strengthen over time as market externalities are priced in," said Liew, adding that good investors must be able to navigate the shift towards ESG trends and more sustainable business models.

Conversely, companies that do not consider transitioning to more sustainable business practices may, over time, see their values decline, especially if consumer demand falls or carbon taxes are imposed, she said.

Climate-related risks and opportunities are managed through a combination of offensive and defensive strategies.

Offence focuses on capturing opportunities that arise from ESG.

"We find that these are not necessarily about investing in 'good ESG' companies while avoiding the 'bad ESG' ones," said Liew.

"There are many good investment opportunities arising from the transition from less sustainable business models to more sustainable ones, and long-term investors such as GIC are well-positioned to play a constructive and meaningful role in supporting the green transition."

Successful transition creates value, both in terms of financial returns and better ESG outcomes, she added.

GIC had invested in US-based Duke Energy to support the transition from fossil fuel and coal-related power plants to cleaner sources of energy.

"GIC will work with Duke Energy and DEI to support their decarbonisation plans and investments in critical clean energy infrastructure, while ensuring that these efforts will not hinder them from continuing to provide reliable services and affordable rates to their vast customer base," said Liew.

Defence, on the other hand, relates to understanding the ESG risks in its portfolio.

"When we make decisions on investing in a particular asset, we integrate such risks into our due diligence. If necessary, we take actions to mitigate the risks, for example by retrofitting our buildings to be more environmentally sustainable, or by engaging the company's management team to encourage them to transition to a lower carbon business model," said Liew.

Opportunities abound

Sustainability is not just about risk management, but also about capturing new opportunities.

"With more governments and businesses making commitments towards net zero, there will be attractive opportunities to invest in green technologies and sustainable business models and products," said Liew.

The energy transition from fossil fuels to alternatives is a significant trend, according to Liew.

"Investors are turning to second-order effects such as the implications of electrification for metal production, and understanding who the winners and losers are in the new low carbon ecosystem, in a bid to be ahead of market trends that are already priced in."

The impact of sustainability issues has also extended beyond "obvious sectors" such as energy and transport to areas such as food and retail, said Liew.

For example, sustainable food is not just about developing alternative sources of protein but deploying innovative technologies across the entire value chain, from farm to fork.

GIC had invested in Apeel Sciences, a US-based company that has developed a plant-based edible coating that slows down the decay of fresh fruits and vegetables - doubling the shelf life of fresh produce. This reduces food waste and enables other supply chain efficiencies that conserve natural resources and avoid carbon emissions.

Liew highlighted that sustainability should not be a ticking-the-box exercise.

"Our ultimate objective is to achieve a low carbon and more sustainable world, and GIC can support this journey by investing in the transition effort. However, these efforts take time and are resource-intensive, so we also need to prioritise our efforts well."

The uphill battle

Integrating sustainability considerations across asset classes may also be challenging and complex given the range and diversity of GIC's portfolio.

The sustainability issues that matter for an insurance company in Europe would be very different from those for a consumer goods retailer in Asia, or a building in North America, said Liew.

Access to data, epecially in the private markets, have put a damper on sustainable investment efforts.

The quality, comparability and materiality of data as well as the lack of common reporting standards have also posed significant challenges.

"This is not a unique challenge for GIC, and indeed the industry is starting to come together to establish some common standards to make ESG assessments easier on companies and for investors," said Liew.

The establishment of the International Sustainability Standards Board by the International Financial Reporting Standards Foundation, for example, has been tasked with developing a single set of high quality, understandable, enforceable and globally accepted sustainability standards.

Collaboration

Based on the belief that sustainability is a company-wide effort that should be pervasive across every function and department, GIC set up a Sustainability Committee in 2016 with representation from across its investment, risk and corporate functions.

No single company can take on climate change on its own. That is why partnership and collaborations will be key towards driving change in sustainable investing.

"We collaborate with investor groups that help companies improve ESG and climate-related disclosures, and share best practices on actively engaging companies" said Liew. "This helps us do things that we can't achieve alone."

GIC had joined the Asia Investor Group on Climate Change (AIGCC), the Carbon Disclosure Project and Climate Action 100+.

GIC, together with 12 members of the AIGCC, is participating in the Asian Utilities Engagement Program, a new investor-led initiative to engage with utility companies in Asia.

• This is the seventh in a 20-part Green Business series, in collaboration with UOB, exploring sustainability trends across businesses and industries.