ESG filters will help your portfolio, wherever you stand on the debate
Regulation and changing consumer sentiment are risks that cannot be ignored, say industry advisers
ROUNDTABLE PANELLISTS:
- Holly So, sustainability strategist at Allianz Global Investors (AllianzGI)
- Victor Wong, head of the sustainability office at UOB Asset Management (UOBAM)
- Sylvia Chen, head of ESG, South Asia, at Amundi
- Mike Ng, group chief sustainability officer at OCBC
- Robson Lee, partner at Kennedys Law
Moderator: Joan Ng, The Business Times
VOICES in favour of investing with an environmental, social and corporate governance (ESG) lens are getting louder, but so are those that believe ESG is a fad.
One reason for the polarisation is ESG-linked investments have not universally outperformed. There is also a lot of disagreement about how to define ESG and measure it, which means companies and investment managers run the risk of over-selling on commitments.
Such hiccups along the road to a more sustainable future may, however, be nothing more than an indication of ESG’s maturity as a concept – the more important it is for investors, the more worthwhile it is for the various stakeholders to argue over what it means.
These were some of the conclusions from a panel of experts in the asset management, financial and legal sectors, who responded to questions from The Business Times about the future of sustainability investing.
As ESG investment principles continue to develop, they said, investors can expect more and better products that cater to a wide range of needs and perspectives. Benchmarks will also improve, giving investors sophisticated ways of evaluating ESG claims. Increasingly, there may also be a greater emphasis on impact.
Meanwhile, investors should be on the lookout for opportunities that are being created by changing regulations. They should also be clear that ESG risks are growing steadily, and prepare their portfolios accordingly. Whatever an investor’s stance on the matter of ESG may be, the use of an ESG lens can only help a portfolio over the long run.
What advice do you have for investors thinking about ESG in the current uncertain climate?
Holly So: We see three macro trends that could shape the sustainability outlook for this year and beyond. First, the political agenda could pack a delayed punch. With more than two billion voters in 50 countries heading to the polls, 2024 is expected to be a significant year for elections. The political agenda risks delaying the financing and implementation of transition plans, which could result in a higher probability of a “delayed transition” scenario, as described by the Network for Greening the Financial System (a network of central banks and financial supervisors). Under this scenario, significant catch-up investment is needed to limit warming to below 2 degrees Celsius. It is crucial that investors understand the potential impact on portfolios in terms of the drag on returns.
Second, 2024 could be the year biodiversity gets the attention it deserves. There is growing recognition of the interconnectedness of biodiversity and climate change, and the targets set at the COP15 biodiversity conference will help put biodiversity at the top of the sustainability agenda.
Finally, we are moving from the transition of regulation to the regulation of transition. The concept of transition finance is steadily being formalised within sustainable investing frameworks. We view this as critical, since transitions reach across ESG, climate, sustainability, and impact investing.
Victor Wong: We think investors should continue to account and adjust for ESG risks and opportunities. While the uncertain climate may pose challenges in advancing the ESG pillars, investors should continue to expect near-term developments in climate reporting, carbon tax adoption and transitioning plans within challenging sectors.
Climate reporting will be impacting more companies as it becomes mandatory for issuers. Investors should also be aware that companies with carbon-intensive operations may incur greater capital expenditure in the long term, which may mean increased risk.
Singapore has also introduced a carbon tax to hold companies accountable for their environmental externalities. The carbon tax level was set at S$5 per tonne of carbon dioxide-equivalent (tCO2e) in 2023, but will be raised to S$50-80/tCO2e by 2030.
Investors in Singapore can tap opportunities created by the Monetary Authority of Singapore’s testing of transition credits to fund the early retirement of coal-fired power plants. Investors can expect companies with high emissions to benefit from such projects that enable a transition to cleaner technologies. Transitioning companies can capitalise on generating verifiable and recognisable transition credits.
Sylvia Chen: While we have seen challenging times in 2023, responsible investment still put up a notable resistance, especially for the most advanced solutions such as positive screening, impact and thematic investment.
Our advice to investors is to stick to responsible investments as they have a strong value proposition. Looking at performance, and referring to MSCI Socially Responsible Investing (SRI) indices to get an objective reference, the MSCI World SRI has significantly overperformed. This trend is observable in both the US and in Europe, with cumulative outperformance over 10 years. While ESG indices were hit in 2022 by the energy crisis, 2023 showed performance recovery in developed markets.
We also advise investors to choose their partners carefully. Amundi’s conviction is that one priority should be bringing clarity to investors. Responsible investment funds are not immune from the economic cycle, and geographical and sectoral biases could have positive or negative impacts on performances. In such a context, clarifying investment solutions features, implications on risk profiles and potential trade-offs is critical to ensuring investors can make informed choices.
Mike Ng: While ESG has become increasingly mainstream, there are some considerations that investors should bear in mind. One is that ESG data gaps still exist, partly due to technology gaps and companies using different metrics and frameworks. These data gaps can hinder investors from effectively assessing companies’ risks, opportunities and ESG performance, and prevent them from making informed investment decisions. It is worth noting though that ESG data quality should mature with time as technology advances. Increased collaboration among stakeholders – asset managers, data providers, and regulatory bodies – will also pave the way for standardised reporting frameworks and taxonomies, leading to enhanced data quality.
Investors can also examine an investment opportunity more deeply by considering the following questions. What is the likely environmental impact of the investment? What kind of companies will the investment be allocated to? Are the companies providing transparent and comprehensive reporting on their ESG practices and performance, and do they follow globally recognised reporting frameworks, such as the Global Reporting Initiative or the Sustainability Accounting Standards Board?
Investors should also keep themselves updated about evolving regulations and policies related to ESG issues. Regulatory changes may impact companies and industries in terms of risks and opportunities, which may impact potential returns.
Robson Lee: Investors should be cautious of possible greenwashing by companies. Greenwashing occurs when companies falsely overrate their environmental standards or misleadingly promote their practices as sustainable to deceive investors seeking to ride the wave of ESG investing. Investors should conduct adequate independent research on each individual aspect of ESG. When in doubt, they should seek advice from appropriate professionals.
A polarising debate is emerging about whether ESG considerations should be core to an investment thesis. Where does your organisation stand in this debate, and why?
So: The ESG backlash, largely from the United States but also touching Europe and Asia, was a response to the overpromising of sustainability over a short-term horizon and the relative underperformance of certain sustainable funds industry-wide.
At AllianzGI, we think sustainable investing has multiple facets. Our role is to help clients navigate the shifts in regulation and other emerging developments, while offering a range of pragmatic and differentiating solutions suited to their situation and ambitions. We provide investment solutions with differing levels of sustainability incorporation to cater to clients’ sustainability objectives and preferences; our product range is categorised into conventional, ESG risk-focused, sustainability-focused products, and impact-focused products. While the last two decades were dominated by ESG scores, we now see clients seeking transparent, measurable, and tangible key performance indicators (KPIs) for sustainability.
Within our sustainability-focused product range, one of the qualifying approaches employs sustainability KPIs as binding elements for our funds. The market push towards KPIs helps align investor and portfolio manager objectives into a single metric while allowing asset managers to differentiate on the basis of their sustainability data strategy as well as research capabilities.
Many of our clients want their investments to bring a positive difference to the world, in addition to seeking attractive returns. This is why we expect to see even more sustainable investing in 2024 and onwards, with the future orienting towards impact investments.
Wong: Sustainability factors are of paramount importance to UOBAM as we recognise our role as socially responsible stewards to drive sustainability. While we invest for profit for our shareholders, we also invest with purpose by incorporating ESG issues into our investment analysis and decision-making processes.
ESG should be an additional value creation tool within the investment thesis while taking into account fundamentals and market developments. Embedding material ESG considerations into the fundamental investment thesis provides insights into investment-related concerns. For instance, assessing the impact of a rise in capital expenditure for carbon-intensive businesses due to regulatory pressures and carbon tax.
UOBAM has a dedicated regional ESG investment team covering all internally managed major asset classes, allowing us to identify ESG trends that are anticipated to cascade down to Singapore and the Asean region.
Investors should integrate sustainability issues into their investing criteria by evaluating how well the target company is managing each relevant sustainability-related risk and opportunity. Material sustainability-related issues can impact the financial value of a company in a positive or negative way. Companies with strong sustainability practices have the potential to offer greater probability or better risk-adjusted returns over the long term.
Chen: The politicisation of responsible investing in the United States and the polarisation of attitudes towards ESG and sustainable commitments create a complex environment for investors and end-savers to navigate. At Amundi, we believe this polarisation of views should be seen as the sign of an industry that is maturing. It shows that beyond declarations, real change is at work.
At the same time, there is a need for clarity in value propositions. While it is important to keep up with emerging laws, attitudes and politics, and continually assess the impact of these developments, it has become even more critical for the industry to bring clarity to the value propositions made at product level and the commitments made at corporate level.
Ng: We view ESG considerations to be crucial for investors, especially for those with a long-term perspective. Integrating ESG factors into investment decision-making can help identify risks and opportunities that traditional financial analysis may overlook, potentially enhancing portfolio resilience in the long run. Aligning investment outcomes with one’s values to do good for the society and environment can also enable the betterment of our world. We observe that certain investors, such as the younger ones, already take a serious view of ESG issues in their investments.
Recent studies have also shown that companies that overlook sustainability may face challenges that adversely impact their success, including reduced access to capital and business opportunities. This would negatively impact returns for their investors.
To help clients understand how ESG factors impact their investment portfolios and the world, our private banking arm Bank of Singapore has published research content extensively on ESG topics in recent years. Since 2020, Bank of Singapore has also partnered MSCI ESG Research to include an MSCI ESG rating in all in-house company research reports. Its research analysts also factor in ESG considerations and commentary in their reports, taking into account sustainability risks and opportunities.
Lee: Institutional investors and family offices are increasingly eschewing businesses that are not ESG-compliant. Banks are also facing regulatory and community scrutiny on their financing activities, and are expected to restructure their loans and financing portfolios away from carbon-intensive industries. Institutional investors, family offices and the banking community players are conscious of their social responsibilities, and are concretely embarking on transitional financing and eventually green financing. Businesses that are oblivious to the tectonic shift in the financial and banking ecosystems will likely face insurmountable difficulties in getting financing in the near future.
Businesses that do not advocate ESG, or retain policies and practices that are not ESG-friendly, are also likely to lose consumer support in the foreseeable future. Consumers are likely to boycott their products and services if such businesses continue to engage in carbon-intensive and/or socially irresponsible operational and sales activities.
Likewise, there are burgeoning groups of socially and environmentally responsible employees who want to work for companies that embody ESG values aligned with their own. Businesses that institutionalise the ESG culture, ethics and values within their organisations would be better placed to recruit and retain a group of well-informed and well-qualified employees who embrace ESG values in their lifelong career pursuits, bearings and mindset directions.
What risks do you think this polarisation creates for investors?
So: This polarisation could send misleading messages to investors on this topic, especially those who may not be as familiar or as sophisticated when it comes to sustainable investing. We are living in a society exposed to numerous potential systemic shocks, be it climate change, the ongoing cost-of-living crisis, or geopolitical uncertainties; integrating ESG considerations into investment research can provide a more comprehensive understanding of the risks and opportunities companies may encounter and their ability to withstand them in the future. Should investors choose to systematically not consider ESG factors in investment decision-making due to this polarisation, there could be a risk of losses in diversification and exposure to higher risks in the long term.
Wong: Polarisation leads to a lack of standardisation and transparency in ESG considerations. Evaluating and conducting comparisons among ESG investment products become more complicated. ESG should be thought of as an additional value creation and risk mitigation tool to complement the investment decisions.
Although this polarisation may create some risks, we have also seen some opportunities in ESG investments and sustainable practices across the region. Within Asean, for example, we have seen large institutional investors in Malaysia and Thailand increasingly requiring ESG in their investment mandates. This may be a result of a top-down push as governments roll out more sustainability initiatives. For companies that export to ESG-advanced countries, they would want to implement sustainable policies and practices to stay ahead of their peers. While there exists a polarising view, we firmly believe that ESG investments will continue to stay relevant.
Chen: In our opinion, the polarisation of ESG brings about two main risks for investors. First, as we strongly believe that incorporating ESG criteria into investment choices provides a source of long-term performance, investors turning away from responsible investment might lose out on potential returns from specific stocks but also on the sustainability mega trends, which will shape tomorrow’s markets.
Second, by not taking ESG into account, investors could expose themselves to a number of risks, which could be mitigated by a robust ESG integration process including a double materiality approach. Controversy risks, physical risks and transition risks are some of the risks investors would face, directly impacting their reputations and the values of their portfolios.
Ng: At its core, ESG can be seen as a risk management tool. ESG assessments help investors assess risks that may be under-emphasised by traditional investment analysis. They can also be used to identify opportunities in a constantly evolving landscape. Investors who downplay the importance of ESG considerations may therefore miss out on potential investment opportunities.
A polarisation of views over ESG considerations need not mean that ESG investing has to be a binary “yes” or “no” decision. Investors can choose an approach that aligns best with their goals and preferences. For instance, investors who are not keen to invest in an emerging green technology can still benefit from thoughtfully integrating ESG factors into their investment decisions.
Lee: The polarisation debate risks tugging investors’ loyalties and accentuating the divide between two broad categories of investors: those whose investment proclivities are focused on traditionally operated businesses that are not environmentally friendly, but generate high profitability and good investment returns irrespective of their carbon footprints; and those who are acutely aware and who are prepared to trade high returns for responsible corporates whose managements are united in the collective global effort to address the underlying causes of global warming, but that do not generate handsome profits in the short term.
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