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A change that is more than skin deep

Sustainability is the current buzzword, but how do investors know if the firms are really committed to make a difference?


''We work extremely hard to try to utilise our history with our partners to be as precise as we can about whom and where we lend money to...'' - Andrew Pidden, DWS Group head of sustainable investments

SUSTAINABLE investing is an approach whose time has come. But even as the number of funds with a sustainable bent rises, whether through an explicit theme like clean energy or the use of ESG (environment, social and governance) scores, investors will still need to discern whether a green label on a fund is only skin deep or signals a firm commitment to make a difference.

Andrew Pidden, DWS Group head of sustainable investments, is uniquely qualified to cut to the chase to determine whether capital can be deployed efficiently in the sustainable space, and still make a measurable impact. He has more than two decades' experience in impact investment.

''Whether we like it or not, the environment has become more challenging globally. The carbon story is far worse than people want to acknowledge and it's far too late to address it. Nuclear energy remains a small percentage of the overall energy mix; oceans are becoming more acidic, soils are more degraded.

''We're going to need to spend capital to green, improve and repair the global biosphere. We're almost at a stage where every investment will have to prove that it is not a destructive use of capital but intended towards doing no harm or bringing about a positive outcome.''

He adds: ''I'm an environmental activist who wears a suit and tie. I believe the (sustainability) space will grow. I think the big institutions without accountability are responsible for a huge amount of environmental damage.''

Mr Pidden holds a master's degree in fi nancial and investment analysis, and a master of science degree in environmental technology. He was a pioneer in impact investing in Asia, having established funds in the 1990s for CLSA Capital Partners. He has also set up clean-tech companies.

The DWS Group manages about US$829 billion in assets as at end-December 2019. The amount in sustainable assets came to around US$700 million as at end-March 2019. It provides private equity and debt investment solutions with an emphasis on social and environment impact.

DWS was among the first signatories of the UNPRI (United Nations' Principles for Responsible Investment), and is accredited by the green climate fund. The fi rm's sustainable investments team is organised around three components: financial inclusion or microfi nance; social enterprise fi nancing (agriculture, health and energy); and energy efficiency or renewable energy.

Says Mr Pidden: ''One of the things that differentiates DWS is its voting record. It votes in favour of every strong climate resolution as part of its governance process - and has done so for a very long time.''

The various approaches that are labelled as sustainable investments typically fall somewhere in a continuum of approaches, ranging from negative screening, to the use of ESG scores and integration to impact investments. While the ESG approach has its value, Mr Pidden's interest lies in impact investments, which typically channels capital into young enterprises which seek to make a measurable impact to the environment or a social objective via their business.

An ESG portfolio, he says, doesn't necessarily set out to do good, ''just less harm''.

Still, ''there is enough analysis to show that an investment that uses ESG generates the same or better returns (than non-ESG funds)'', he says.

''Normally, the piece that gives better return is governance. If your governance fi lters are strong enough to say that management isn't as clean, open or transparent as you'd like, and you avoid those companies, you'll outperform substantially.''

On the other hand, an impact investment explicitly seeks an impact outcome as well as a financial return. Typically, the investee companies have a sustainable, profitable business, but are not large enough to secure bank financing.

''They have a track record and good profi ts. You can see that they'restructured as a business and are sustainable. When eventually they get more established they can go to the bank or list the company. We're earlier in the capital cycle, but still return oriented.''

Mr Pidden says there are a number of challenges in the impact investment arena, whether in private equity or private debt. One is that fund sizes tend to be smaller particularly in the area of microfinance or credit.

This is a function of the underlying portfolio investments in companies whose businesses have yet to achieve scale. This may be a deterrent to large institutions looking to deploy substantial capital in impact funds.

''Sometimes, you hear a lot of noise on how much capital can be raised. But you only raise capital when you can deploy it . . . Microfinance in the 1990s used to lend US$20,000 to US$50,000. Now we can lend US$5-10 million to the same institution as they've grown enormously. But we can't lend US$100 million without taking up too much of the balance sheet. It's the same for the environmental technology space in China.

''Today we can invest US$30-40 million as private equity in small companies, where we want 30 per cent of equity. But we don't want to invest US$300 million because then we're talking about a company that's worth US$1 billion. You're not going to find a small growing company focused on clean building materials or some form of energy effi ciency that's worth US$1 billion.''

In some segments, the measurement of the outcome may also be a challenge. ''Microcredit in particular has been criticised for over-lending and inappropriate outcomes. We work extremely hard to try to utilise our history with our partners to be as precise as we can about whom and where we lend money to, to make sure the people we work with have as clear a process as possible… You can never claim only positive outcomes. Typically we have positive and negative outcomes.''

''Our view is and has been that well-run microfi nance institutions are mindful of the risk for abuse, and that is why we have been a long-time supporter of the Client Protection Principles, housed within the Smart Campaign, which lays out a code of consumer protection for the microfinance industry.''

Smart Campaign is working with financial leaders from around the world to provide institutions with the tools and resources they need to deliver transparent, respectful, and prudent financial services to all clients. Green bonds are another area where the hype may well overshadow reality.

''It's a fast way to raise capital. Clearly, major investors want to point to the green portion of their portfolios. There is no way that all the corporations taking in billions in green bonds are solely using them to improve their carbon footprint and emissions profile.

''Where is the actual hard disclosure on the use of capital? It makes me cautious. I don't want to stop the growth of green finance. This is an important part of the future. The issue of resource degradation can only be addressed by mobilising billions of private capital. But if it is misused early in the process, and people become cynical about its value and reputation, it is not helpful.''

Meanwhile, fund raising for sustainable causes will be challenging as markets and economies are roiled by the ongoing Covid-19 pandemic. Still, Mr Pidden believes there may be a silver lining.

''After the 2008/9 financial crisis, the impact space took some time to come back into focus. But then it evolved to become a much bigger area of focus as investors realised that capital allocations increasingly require a social reason for being.

''I expect this to repeat itself, initially with a focus on sustainable food production, waste management and cleanliness (less pollution). It will roll on to fewer flights and less frantic capitalism as people remember time (alive) is more important that money or material goods.''



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