Sustainability is key

THE BUSINESS TIMES' WEALTH ROUNDTABLE

Genevieve Cua, BT Wealth Editor, poses questions to asset managers for their insights on sustainability in fund management

Sandra Carlisle, HSBC Global Asset Management, Head of Responsible Investment. Sandra is a board member of the Principles for Responsible Investment. She is a keen yoga practitioner and equestrian.

Jennifer Wu, BlackRock, Director of Sustainable Investing. Jennifer is responsible for creating innovative investment solutions to deliver purpose and performance across asset classes. She enjoys long-distance trail running and hiking.

Leon Kamhi, Hermes Investment Management, Head of Responsibility. Leon is responsible for developing and directing the programme for integrating responsibility across the Hermes group. He enjoys spending time with his family and globetrotting.

Thierry Bogaty, Amundi Asset Management, Head of SRI Expertise. A former journalist, Thierry is also vice-chairman of the stewardship, market integrity, ESG standing committee at EFAMA (European Fund and Asset Management Association).

Interest in sustainable or responsible investments is on the rise. Genevieve Cua speaks to the Wealth panel of fund managers on why this is significant and whether the trend is here to stay

How important is some form of sustainable/responsible investing to your firm and why should investors care?

Sandra: Responsible investing is integral to our investment philosophy and approach. We analyse material ESG (environment, social, governance) issues and seek to invest in companies that account for their broader impact on society and avoid excessive risk-taking. Investors care because they increasingly believe that social and environmental concerns are just as important as the bottom line.

Jennifer: Sustainable investment lies at the core of BlackRock's business, as an asset manager and a fiduciary to our clients. Our objective is to create better financial futures for our clients and the people they serve. This is embedded in our values. BlackRock's CEO and chairman Larry Fink is a public proponent of long-term investing, and routinely articulates the value of sustainable investing, investment stewardship, and corporate ESG disclosure.

We also outline in our Mission Statement on Sustainability that we aspire to be an industry leader in terms of how we incorporate sustainability into our investment processes and learnings across the firm; stewardship of our clients' assets; sustainable investment solutions offered to our clients; and operations of our own business.

From BlackRock's perspective, business-relevant sustainability issues can contribute to a company's long-term financial performance. Further incorporating these considerations into the investment research, portfolio construction, and stewardship process can enhance long-term risk-adjusted returns. By expanding access to data, insights and learnings on material environmental, social, and governance (ESG) risks and opportunities in investment processes across our diverse platform, we become better overall investors.

Investors should care because sustainability-related issues - ranging from board composition to human capital management to climate change - have real financial impacts. We are passionate about providing our clients with a clear picture of the relationship between sustainability issues, risk and long-term financial performance. With this picture in focus, we aim to deliver investment solutions that empower our clients to better meet their financial objectives.

Leon: Hermes' purpose as an investment firm is to deliver long-term holistic returns for beneficiaries. Hence, through both our investment and stewardship activities, we will aim to deliver a positive social and environment impact from our investments alongside a superior long-term investment return. The end beneficiary - the investor - cares because together with an adequate pension income, he or she wants to be able to afford goods and services and live in a stable society and positive environment. To do so requires investments that are long-term sustainable by meeting the needs of customers, employees and society at large as well as providing a financial return to the shareholder.

Thierry: Responsible investment has been the starting point in Amundi's investment policy. When it was created in 2010, Amundi made social and environmental responsibility one of its four founding pillars. We have been a leader in asserting the responsibility of the financial sector in the pursuit of responsible investment policies. We have very quickly caught the importance of integrating ESG criteria in its investment policies.

This commitment is based on two convictions: the responsibility companies and investors have in building a sustainable society, and the belief that responsible investment is a guarantee of long-term financial performance. Responsible investment has made its place in the market and is developing at high speed around the world. Today, it has become investors' new norm and their motivations are multiple.

Responsible investment helps to identify risks that could have an impact on performance (reputational, operational, financial or regulatory risks). It allows investors to benefit from financial opportunities linked to sustainable development such as renewable energy. This process enables investors to have a social and environmental impact, and to be in line with their fiduciary duty.

Currently, Amundi, the largest asset manager in Europe, manages about 1.5 trillion euro (S$2.4 trillion) of assets, 1.4 trillion euro of which are subject to exclusion policy and 280 billion euros (19 per cent of the total AUMs) in a sustainable manner.

Investing with an ESG orientation has gained a lot of traction in the last couple of years. Can you please share with us your firm's approach towards ESG integration; why is this important; and does the approach permeate across the board on portfolios you manage?

Sandra: In 2010, HSBC Global Asset Management decided to integrate a separate team of ESG analysts as part of our investment teams. We also undertook an ESG education programme for all of our analysts and portfolio managers. This means that ESG analysis is fundamental in how our portfolio managers and analysts look at companies and make their investment decisions along with enhanced due diligence for any high-risk company.

Jennifer: BlackRock is committed to integrating sustainability insights - often referred to as ESG - into our investment processes. We define ESG integration as the practice of incorporating material ESG information into investment decisions in order to enhance risk-adjusted returns. This should be part of any robust investment process. It means adapting our research and core investment processes to account for additional sources of risk and return that are explained by ESG information. ESG integration is relevant for all asset classes and styles of portfolio management, public and private markets, and alpha-seeking and index strategies.

The BlackRock sustainable investing team coordinates the global effort, provides consistency and ensures quality across our diverse investment platform. The team partners with other investment teams, who have ultimate ownership of and control over the implementation of ESG integration, to tailor processes for each group. Our goal is to enable all teams to reach a minimum level of ESG integration, and to support all teams in their plans to deepen their own capabilities. We plan to selectively add to ESG data and research resources, develop tools to improve investor access to ESG information, and increase the accessibility of proprietary investment insights from sustainability information. BlackRock currently manages a broad suite of investment solutions on behalf of our clients, in which sustainability themes are central to mitigating risk and enhancing long-term returns. There are four main segments of products and services.

Leon: At Hermes, we integrate awareness of sustainability factors (including ESG) and engagement activity into each and every one of our funds. We do this for both our mainstream and thematic funds. Each team will tailor the integration to its own investment strategy with fundamental analysis for our bottom-up funds. In doing so, if the engagement is successful, it delivers positive social and environment outcomes alongside a financial return. Further, we contend that the engagement insights gleaned provide superior information in considering the risks and value opportunities of an investment.

Thierry: Amundi's responsible investment approach is built on three main axes: Best-in-class approach, exclusion and engagement. A best-inclass approach selects the companies that best handle their ESG risks and opportunities in each sector. This analysis is reflected in a rating, circulated to the fund managers to help them in their stock selection with a better sustainable perspective.

We also apply strict rules for exclusion in all active portfolios. We exclude companies that do not comply with our ESG policy, with international conventions and texts with a universal scope, or with national law regulations. We exclude the companies active in the following businesses: anti-personnel mines, cluster munitions, chemical weapons, biological weapons, depleted uranium weapons.

We have also implemented specific sectoral exclusions for controversial industries. We exclude issuers that derive over 25 per cent of their revenue from coal mining or that produce more than 100 million tonnes of coal each year. We also exclude tobacco in our open-ended SRI Funds.

With regard to engagement, three axes are deployed: Engagement for influence, which aims to understand existing practices, make recommendations and measure the progress made. The on-going engagement aims to improve the analysis of risks and opportunities that businesses face and support companies in the improvement of their sustainable practices. And finally, engagement through vote which Amundi uses to create direct dialogue with the board of directors.

How challenging is it to invest with a socially responsible approach in Asia?

Sandra: It is no more or less difficult to invest responsibly in Asia than in other markets. As part of our stewardship approach, we engage with companies globally and in 2017, over 50 per cent of our engagement was with Asian companies, versus 30 per cent in Europe and Middle East and 12 per cent in the Americas.

Jennifer: As the fastest growing region in the world, Asia presents a huge opportunity for sustainable investing. Driven by demographic shifts, technological advancements and new wealth creation, BlackRock sees tremendous potential for greater adoption in the region.

While the sustainable investing market remains small relative to the other parts of the world, we expect Japan and Australia to lead the way. Both nations are in strong positions to increasingly adopt sustainable investing due to their respective regulatory frameworks.

Elsewhere in Asia, there has been an uptick in large institutional investors and wealth platforms seeking ways to allocate capital into ESG investments and to align purpose with their investments, most notably in Singapore, South Korea and Taiwan.

With high digital adoption rates and the proliferation of e-commerce, we see a unique opportunity to develop a more comprehensive view about the ESG profile of corporations. Furthermore, we believe that there will be wider adoption of ESG into the investment process by investors in Asia. This rings true especially for markets in which there are higher geopolitical and idiosyncratic risks, and where additional ESG insights may help investors mitigate risks and potentially enhance return.

BlackRock is committed to providing our clients in Asia with investment solutions to meet their long-term goals, and we view sustainable investing as an avenue to do so. We are also engaging with companies on sustainability issues to advocate for ESG excellence on behalf of our clients, including more consistent, frequent and standardised reporting of ESG-related metrics with data providers, companies and regulators.

Leon: Asia is made up of many countries and each will have their own regulatory and governance norms. Often in Asia we come across challenges in the quality of corporate governance and related disclosures. This could be in the level of independence or diversity on a board or simply in the notice given prior to an annual general meeting. Availability of relevant sustainability information can also be poor.

Access to board members in an Asian company is typically quite limited. Overall we have seen significant improvements over the last few years as more and more companies recognise that enhancing their socially responsible practices is attractive to a wider and international investor base.

Thierry: Even though responsible investment in Asia was growing more slowly than in other parts of the world, the Global Sustainable Investment Alliance 2016 report stated that investors are adapting their portfolios to ESG criteria more and more.

In the past two years, ESG issues are increasingly taken into account in this area since the urgency of environmental concerns intensifies each day. The Paris Agreement on climate change has taken part in disrupting investment methods, and investors in Asia have participated in environmental opportunities, especially in China through green bonds.

Investors may be concerned that investing responsibly (even if just an ESG discipline) will entail sacrificing returns. What are your thoughts on this?

Sandra: Our approach to ESG integration is materiality-based. In other words, we believe that ESG issues can have a material impact on company fundamentals and performance over the longer term. ESG issues are linked to opportunities and risks that the market may be mispricing. For us, it is a question of protecting and enhancing returns through investing responsibly and integrating ESG analysis, not sacrificing returns.

Jennifer: We believe strong ESG performers tend to exhibit operational excellence - and are more resilient to perils ranging from ethical lapses to climate risks.

We believe it is feasible to create sustainable portfolios that do not compromise return goals and may even enhance risk-adjusted returns in the long run. To that end, we recently published a paper titled "Sustainable Investing: A Why Not Moment" (https://www.blackrock.com/corporate/ literature/whitepaper/bii-sustainable-investingmay- 2018-international.pdf ), which takes a deep dive into equities, fixed income and real assets; showcases big data research; and highlights BlackRock's engagement efforts.

From a performance perspective, it is worth noting that ESG has a lot in common with existing quality metrics. This implies that ESG-friendly portfolios could lag in "risk-on" periods - but be more resilient in downturns. Furthermore, new benchmarks and products are making ESG investing more accessible across asset classes and regions. Data is improving, but still patchy. It is critical to go beyond headline ESG scores for alpha generation.

Finally, issues such as shareholder protections, natural resources management and labour relations can be important performance differentiators in the EM world. Ultimately, sustainable investing is about combining traditional investment approaches with additional insights around ESG issues that are material to the longterm financial performance of companies and underlying assets, with the goal to enhance longterm risk adjusted returns. By expanding access to data, insights and learnings on material ESG risks and opportunities in investment processes, we become better overall investors.

Leon: The vast majority of the academic evidence we have seen suggests there are positive returns and reduced risk to both positive ESG investing and to engagement activity.

Our anecdotal experience from the management of our funds and the significant engagement experience we have accumulated is that responsible investment considerations are at worst neutral, but very often positively additive for a mainstream fund. Some thematic funds will outperform and others underperform as is the case with mainstream funds. Therefore, we don't believe a responsible investing approach entails sacrificing returns. Quite the opposite.

Thierry: We are convinced that value creation and sustainable development are now linked more than ever: ESG issues represent financial risk factors for investors, and are also opportunities.

Sustaining financial performance over the long run requires long-term strategies. A company that respects the environment, values its human capital, and has good governance practices is better equipped to outperform economically and financially in the long run. ESG scoring criteria reflect the best practices in each sector, help to evaluate the risks companies are exposed to and to identify opportunities.

Interest in ESG investing has incontestably grown in recent years globally. Amundi has been conducting thorough studies to evaluate the impact of ESG criteria on portfolio performance, first in 2014 and more recently this year.

ESG best-in-class strategies used to provide globally neutral results before 2014. A focus on shorter periods clearly highlights a positive selection effect on well-rated companies, sometimes combined with the underperformance of poorly rated stocks. The study demonstrates, however, that ESG issues are not perceived in the same way from one region to another. This has an impact on ESG analyses and on investments.

The study also explains that ESG factors can have a slightly positive effect on drawdown reduction. The persistence of ESG performance across time and regions, combined with the growing interest of investors in ESG, raise the question of the mutation of ESG from an alpha source of performance for active management into beta, feeding the booming factor investing segment.

ESG today really does matter and investors cannot be agnostic on this matter.