Entrenching sustainability trends

THE BUSINESS TIMES' WEALTH ROUNDTABLE

Genevieve Cua, BT Wealth Editor, poses questions to experts for their insights on sustainable investments

Garth Bregman: Head of Investment Services, Asia Pacifi c BNP Paribas Wealth Management

Thomas Fekete: Head of Sustainable Investing EMEA and Asia BlackRock

Jenn-Hui Tan: Global Head of Stewardship and Sustainable Investing Fidelity International

Marc Lansonneur: Head of Managed Solutions, Balance Sheet Products, and Investment Governance DBS Wealth

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Sustainability has risen to even more prominence since the onset of Covid-19. To date, sustainable funds - or those managed with an ESG (environmental, social, governance) discipline - have outperformed. Is this a megatrend with legs? We ask our panel of experts.

Sustainability in investments appears to be gaining traction. What are the chances that this trend becomes entrenched?

Garth: Covid-19 has exposed some weaknesses in our socio-economic fabric. It is a wake-up call that we should build more resilience into these systems, with key focus on reducing inequality and taking into account the clear and present danger of climate change. Going forward, companies are likely to adopt more sustainable and resilient business models. At the same time, investors are becoming more aware of sustainability issues and how they can impact their portfolios. Sustainability is a megatrend, it is here to stay and will accelerate industry-wide change.

Investment opportunities in sectors including energy-related renovation of residential housing, decarbonised transportation like electric vehicles or ''soft mobility'' types of transport (e-bikes, car sharing) could create large numbers of jobs and safeguard the environment.

Demand for sustainable and responsible investment products is being driven partly by millennials and the younger generation who are knowledgeable about sustainability issues and attracted to investments that align with their values. Many institutional investors (pension funds, insurance companies) are also pushing the sustainability agenda.

Thomas: Through the Covid crisis, we have seen two things: A strong correlation between sustainability characteristics and factors such as quality and low volatility, which led to increased resilience and better risk-adjusted returns. And, investors have increasingly sought out sustainable investment strategies amidst uncertainty this year.

Our research also shows the rising salience of stakeholder-centric issues, including how businesses engage with customers, communities and employees. For example, companies that report higher levels of employee satisfaction and stakeholder engagement were the most resilient throughout this period.

In the multiple calls and polls BlackRock conducted globally, an overwhelming majority (90%+) of respondents believe that sustainability characteristics will become more important coming out of the pandemic. Pollution and climate change risks rank high among the concerns of the countries such as China and Indonesia.

Jenn: Throughout the Covid-19 outbreak we've seen increased emphasis on companies' societal responsibility. The crisis has reinforced our underlying belief that companies fundamentally exist to provide products and services which serve the needs of society: Profit represents the successful outcome of a company fulfi lling its purpose, it is not the purpose of a company itself.

This was confirmed in our recent pulse survey of 149 Fidelity International analysts in May and June which revealed sustainability considerations taking precedence over profi t maximisation at most companies globally. Only 15 per cent of our analysts reported that companies would not be willing to sacrifi ce some level of earnings in order to pursue a sustainable agenda.

In addition, nearly 70 per cent of our analysts reported that they expect that some or most of the emphasis on social-related factors would become permanent even beyond a resolution of the Covid19 crisis in their sector. This is an important shift, as until now the discussion around ESG has often focused on the "E" (environment) and "G" ( governance). We are now seeing increasing awareness of the criticality of the "S" (social).

Beyond the impact on companies, it is clear that the global pandemic is accelerating trends that were in motion even before the crisis, most notably a shift towards a more stakeholder oriented form of capitalism and away from purely considering the needs of shareholders. In our view, this is a permanent and structural shift in fi nancial markets and in wider society.

Marc: Today, integrating sustainability criteria into investment decisions is widely embraced by professional investors (eg sovereign funds, asset managers), and we're seeing growing interest amongst private investors in recent years as well - a trend that has accelerated since Covid-19 emerged. Covid-19 has intensifi ed societal issues worldwide, and some perceive the pandemic to be attributable to poor sustainability practises. Against this backdrop, we can expect this trajectory of rising awareness, interest and demand for sustainable investments to continue.

How can investors discern whether an investment or fund is truly sustainable or in name only?

Garth: Today, the development of the sustainability ecosystem has attracted more participants and greater demand for more disclosures and transparency. We have better data, better tools and more expertise to analyse the ESG features of a given investment or fund. This will help prevent greenwashing.

The EU has established an EU taxonomy, a classifi cation system for sustainable activities. European countries have their own specifi c labelling systems (Febelfi n in Belgium, Label ISR in France, LuxFLAG in Luxembourg) to guide retail investors on the quality standards of a sustainable product. European based asset managers have to "pass" these standards in order to obtain a sustainable label on their products.

In Asia, the Hong Kong SFC has developed a framework for green and ESG funds and the list of compliant ESG funds is available on its website.

Wealth managers and distributors can adopt some of the well-known third party ESG rating standards (MSCI or Morningstar) or develop their own ESG rating methodologies. BNP Paribas Wealth Management has developed a proprietary ESG rating methodology to analyse each fund. Fund houses are requested to complete a detailed questionnaire followed by our assessment process of their specifi c fund. We will then do the scoring in-house.

Thomas: The concept of sustainable investing can mean different things. For some, it is a dedicated effort to avoid exposures. In general, Asian investors are focused on either ESG or thematic funds oriented towards the fight against climate change. Outside of Australia/NZ, we see less interest for funds which only implement exclusions. This is because Asian investors are still more focused on returns and less on the moral/ethical drivers for sustainable investing. Asian investors see climate risks as investment risks and are increasingly convinced that broader sustainability risks are also investment risks.

BlackRock operates from a simple defi nition of sustainable investing: Combining traditional investing with ESG-related insights to improve long-term outcomes for our clients. We see that companies with strong profiles on material sustainability issues have potential to outperform those with poor profiles.

We observe that regulators and stock exchanges in Asia-Pacifi c are increasingly focused on how to achieve a common approach to sustainable fi nance terminology. A common theme has been a sharp regulatory focus on issuer disclosure, with the key jurisdictions either imposing or promoting voluntary compliance with ESG reporting frameworks

Jenn: There is no substitute for due diligence - simply relying on a label to assure an investor of green or sustainable credentials is not suffi cient. This is equally true at an issuer and security level - it is important not to simply accept company disclosure at face value but to do your own analysis and form your own conclusions on whether the sustainability/green characteristics are truly intrinsic to the business or whether they represent surface level considerations only.

For investors, what value-add does ESG give and how quantifiable is this?

Garth: There is limited added value from ESG considerations for short-term trading. For long and medium-term investing, however, ESG indices have outperformed traditional benchmarks.

Many academic studies have also shown that incorporating ESG factors into the investment process leads to better risk-adjusted returns. It is a combination of managing the tail risks (of investing in a sector or a company that could, for example, be signifi cantly impacted by climate change or any other sustainability issues) and finding new investment opportunities for a more sustainable world. ESG investing is an enhancement of the traditional investing approach. Financial analysis remains crucial, with ESG analysis providing additional depth to the investment process.

Thomas: In Q1 2020, we saw better risk-adjusted performance across sustainable products globally. While this short period is not determinative, these results are consistent with the research BlackRock has been publishing since mid-2018. BlackRock research across market cycles supports our view that sustainable strategies do not require a return tradeoff, have important resilient properties, and can offer investors better risk-adjusted returns that integrate sustainability-related issues into traditional investment strategies.

We find that, beyond sustainable indices, openended funds that score in the top 10 per cent of Morningstar's sustainability ratings have signifi cantly outperformed low-scoring peers (bottom 10 per cent). We analysed the Q1 2020 performance of 6,759 open-ended funds, comparing those with high sustainability rankings to those with low sustainability rankings, relative to their peers (in the respective Morningstar Category). According to Morningstar, the returns of 70 per cent of sustainable equity funds ranked in the top two quartiles in Q1 2020, and more sustainable funds' returns ranked in their category's best quartile than in any other quartile. Meanwhile, funds in the bottom 10 per cent on sustainability tend to rank near the bottom for fi nancial performance as well.

Jenn: There is clear evidence, also reinforced by this crisis, that incorporating ESG considerations in a fundamental research process is helping investors to select better performing public market assets - fi rstly in managing downside investment risk but increasingly as a positive selection criteria for investment opportunities. In our view, sustainability is fundamentally becoming a proxy for quality of management itself. Long-term oriented boards and management teams will pay attention to these factors because they recognise their importance in driving long term value creation within companies.

This was demonstrated recently in a study which Fidelity conducted using its proprietary ESG ratings. Over the initial period of market volatility in February and March, we observed a linear correlation between companies' relative market performance and higher ESG scores. The equity and fi xed income securities issued by companies at the top of our ESG rating scale (A and B) outperformed S&P500, and those with average (C) and weaker ratings (D and E) underperformed the index, with an average of 2.8 per cent of stock performance between each rating level.

In our view, this was because companies with superior sustainability characteristics are managed by more prudent and conservative management teams and will therefore demonstrate greater resilience in a market crisis.

Marc: There's a growing body of research suggesting that companies with stronger ESG focus outperform their peers in the long run, and recent studies too indicate that ESG investments performed better than traditional portfolios during the recent market turmoil.

As these data suggest, the benefits of integrating ESG criteria into investment decisions for investors are clear - investments with higher ESG ratings are well-placed to strengthen investors' portfolios by providing better protection against E, S and G risks, and are also more likely to deliver superior outperformance in the long run as compared to ESG laggards. With ESG, investors can achieve a "win-win" where they're benefi tting fi nancially whilst also doing good for society.