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Can ESG factors truly drive investment returns? We asked the experts 6 July 2021 
ESG (Environmental, Social, Governance) practices have been parading up Wall Street. Can ESG factors truly drive investment returns and should investors jump onto the bandwagon?
1) Is ESG / sustainable investing a passing fad? Why should investors be concerned about it and does it matter to their investment portfolio?
Eastspring: From an investment perspective, we view sustainability as an investee company’s ability to create long term value. Rather than being a fad, we believe this is a central investment concept. Companies and investors alike are getting more aware of the impact of poor ESG practices and opportunities arising from ESG trends. Governments globally are also taking heed with more countries setting carbon emission goals; China has announced its goal to be net carbon neutral by 2060, while Korea and Japan have committed to be carbon-neutral by 2050. The combination of investor awareness, environmental urgencies and government drive is expected to translate into rising costs for companies continuing to ignore ESG risks. The growing prevalence of ESG plays also underpins the importance of this space going forward.
PineBridge: ESG screening has now become an important litmus test in portfolio selection and management. Sustainable investments are an essential part of our research process and not merely an additional screen to construct and run the portfolios. We firmly believe that businesses following unsustainable practices would not be able to compete or demonstrate any long-term advantage versus companies with sustainable policies in place.
2) Should standardization and regulation over ESG practices be welcomed?
Aviva Investors: A lot of incoming regulation is focused on standardization of information disclosure and categorization of investment offerings. We believe this is to be welcomed as inconsistency will only reduce confidence in investment products that incorporate ESG characteristics. The introduction of taxonomies – classification systems that define sustainable economic activities – is a positive step. As the adage goes, you cannot manage what you cannot measure. Fund classifications will enable investors to compare investment products with more confidence.
Nikko Asset Management: Regulation and standardization of ESG is inevitable and has already started in Europe with SFDR (Sustainable Finance Disclosure Regulation) & the EU Taxonomy. We welcome this as it should give clients the confidence that they are investing in products that help provide for a more sustainable future. In a similar way to the financial accounting industry, standardization of the measurement and reporting of data is likely and although the journey to reach global standardization will be long, the benefits for investors and society alike will be meaningful.
3) How do you distinguish greenwashing from actual ESG outputs? How do you encourage your investment options to report on their ESG performance truthfully?
Aviva Investors: Greenwashing has become more widespread and sophisticated in recent years and comes in a variety of shades – such as a lack of evidence for green claims; vagueness; irrelevance; outright lies; exaggerations; hidden trade-offs; and the “lesser of two evils” argument, where companies argue for the environmental benefits of fundamentally polluting products like cigarettes or crude oil.
As greenwashing can result in reputational damage, regulatory fines and have a sizeable impact on company share price, Asset managers have an obvious incentive to ensure the companies they invest in are backing up their green claims. From a due diligence perspective, asset managers have a key role to play in fighting back against the practice and there is no substitute for engaging directly with company executives to determine their commitment to sustainability.
Eastspring: There are no short cuts to distinguishing greenwashing other than through in-depth research on companies to understand the materiality of ESG risks and how the companies are dealing with these risks.
For instance, when investing into bonds, we do not automatically exclude issuers in controversial industries. Instead, we prefer to assess the effort that such companies are making to remain relevant and whether they may be effecting positive changes within their industries during the process.
At Eastspring, we do not simply rely on external ratings and assessments but draw on the strengths of our large credit research team. While credit worthiness is still a key pre-requisite, all securities and issuers are subject to an additional set of ESG risk evaluation criteria. We also believe that active engagement with investee companies goes a long way to improve ESG practice and management.
4) How does your ESG criteria impact investment decisions and portfolio construction?
PineBridge: We recognise that ESG issues may create both opportunities and risks for our clients’ portfolios. PineBridge is a signatory of the United Nations Principles for Responsible Investment ("PRI"), which provides a framework to report and assess ESG factors. We see the PRI as an additional tool to help us pursue our objective as an asset manager: Improving and preserving our clients' financial interests by optimising economic returns for a given level of risk.
At PineBridge, we address these factors through our investment process to better understand their potential impact on current asset values and future performance. As ESG factors can differ materially across the diverse range of asset classes, geographies, sectors, and specific investments, our investment teams in each investment area decides on the most appropriate manner of PRI and ESG integration into their investment process.
Nikko Asset Management: For the Nikko AM Global Equity Team, we consider ESG throughout our investment process – from idea generation through to reporting to clients. The style of company we invest in means we can create a portfolio with a low carbon footprint and avoid companies that may suffer from controversies. A large portion of our portfolio is invested in companies that are solving many of the issues faced by society, whether decarbonization, air quality or improving healthcare for everyone. The net result is a portfolio that creates wealth for our clients while also matching their ESG needs.
5) How does strong ESG credentials translate into superior potential long-term performance?
Eastspring: ESG considerations can be both financial and non-financial in nature and present both risks and opportunities for investors. We believe that companies, which are quick to identify critical ESG risks in their business can prepare adequately for the challenges and gain competitive advantage over time. An understanding of a potential investee company’s preparedness to address risks and opportunities that impact their ability to create long term value may contribute to more effective investment decisions over the medium to longer term.
6) How do you manage attractive investment options with poor ESG credentials?
Aviva Investors: We are big fans of company engagement, which can generate outcomes that benefit clients and in many cases society, the environment and the broader economy. As an active owner of capital, our scale and influence help us drive the change required to build a future our clients are able to retire into.
Whether investing in equities, bonds, real estate or infrastructure, integrating ESG into our investment decisions and being responsible stewards of clients’ assets is non-negotiable. Understanding these issues allows us to spot and manage investment risks, as well as capture exciting new opportunities. Through our active ESG engagement programme, we can be a force for positive change in our economy and society.
PineBridge: Investment professionals at PineBridge have the discretion to discuss and debate to gauge not the state of being for a company but its future form within a reasonable timeframe. Our method utilises the same principle as any other aspect of fundamental investing – historical information and trends are useful, but the key to success is determining where the company is headed in the future. Through this process, we score each company on four key dimensions: (1) Governance & Leadership, (2) Business Sustainability, (3) Financial Strength, and (4) Valuation.
Our due diligence frameworks provide an assessment of where the company is travelling and not simply where it stands currently. Sound fundamental analysis which, fully integrates ESG, provides judgment and forecast on the evolution of the business over time, and the security selected should be rewarded with a higher valuation as these projections are realised.
Don't fly under the radar As regulators and governing bodies continue to streamline ESG practices and drive standardisation, the notion that ESG is but a passing fad seems increasingly challenged. Since ESG presents both opportunities and risks, it might pay to keep ESG on your radar.
While not all funds have green labels or green names, many asset managers already have ESG integrated into their investment, portfolio, and risk management processes. With more than 1,000 funds on our platform, there are plenty of investment options for you to invest into.
Open an account and start investing today!
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