The topic of sustainable investing is moving into the mainstream but who is responsible for driving the trend? When it comes to matters of environmental, social and governance (ESG) issues is it investors who should be forcing companies to change, or companies that should be taking the lead?
Courtney Ranstrom, co-founder of US financial advice firm Trailhead Planners, says investors need to push companies to be more conscious of their environmental impact. Advisers have a key role in this, he says, and should be looking at how to analyse ESG risk factors and incorporate them into their investment processes.
But sustainable investing shouldn’t be forced on to clients, he adds: “We don’t require that our clients tilt toward ESG investments, but we offer it for our clients who want it.” He does, however, believe that investors should be pushing companies to be more conscious of the long-term environmental risks their businesses face and their responsibility in creating inclusive working environments – while still generating profits, of course.
It’s a stance Sam Orgrizovich, founder of adviser firm OFM Wealth, agrees with. He realised in 2016 that issues around climate change, consumer privacy and corporate governance were becoming increasingly problematic and should be taken into account when investing.
“Our increased awareness of ESG issues and the connection between those issues and potentially profitable ESG products led us to conclude that our sustainable investing initiative was clearly in our clients’ interests,” he adds. Indeed, around 70% of clients have expressed an interest of incorporating some form of ESG screening into their portfolio - it shows sustainable investing is not a “fringe” investment strategy, says Ogrizovich.
Sustainable Investing Should be Win-Win
This message has certainly hit home for Aurelio Bustilho, chief financial officer of South American utilities firm Enel Americas (ENIA). He wants to protect the company’s Narrow Moat Rating by focusing on ESG factors. “ESG is part of our business strategy. If we don’t take this approach, we won’t get any business,” says Bustilho. To this end, the business avoids projects that a community doesn’t want. “It should be a win-win approach in order to reduce risk,” he explains.
One project the firm is involved with is providing 500 electric buses in Bogota, Colombia, to try and reduce carbon emissions in the city. Meanwhile, because prices are very competitive, solar energy is a growing market in South America and particularly Brazil, where Enel Green Power has built the biggest solar plant on the continent. The company is also investing around $20 million a year in public lighting infrastructure, while in Colombia and Peru it has started a business which offers finance on white goods.
As well as improving social issues and inclusion, projects that help to solve energy and efficiency problems are particularly important, says Bustilho, when you consider that by 2030 around 85% of people in Latin America will live in big cities. “Part of it is to improve the quality of life in cities,” he adds. “Given the movement of people to cities, you must transform the cities.”
Bustilho adds: “Yes we believe in addressing climate change, but ESG is also an economic decision to be transparent, to have clear governance in the company and to respect the social and environmental approach.”
ESG Forces Investors to Think Long-Term
Masja Zandbergen, head of sustainability integration at Netherlands-based asset manager Robeco, says taking ESG factors into account forces fund managers to take a long-term view. “We believe it contributes to society and makes us better investors,” she adds.
For Zandbergen, valuation is the starting point for investing and then applying ESG analysis helps her team to find interesting companies that are also managing ESG risks effectively. Indeed, analysing companies in this way has helped her avoid falling into so-called value traps, where shares are cheap but for a good reason. “We have many examples where bad corporate governance, for example, prevented us from investing in a company and that turned out to help us tremendously,” says Zandbergen.
Areas where ESG risk analysis is particularly vital are carbon-intensive industries and those with a high risk of human rights violations or risk of accidents. This can include energy, utilities, car manufacturers and mining companies.
But while climate change is a high-profile issue for many ESG-focused investors, Zandbergen thinks corporate governance is the most important area to consider, including areas such as supply chain management and licenses to operate. Other big themes of the past year have included the social issues around artificial intelligence, single-use plastics and digital healthcare.
Of course, the ESG space is rarely a clear cut one. While carbon-intensive industries require in-depth analysis, a fossil fuel company that is working towards energy transition and has a good record of health, safety and human rights could be a good fit in a sustainable investment strategy, points out Zandbergen. “In such cases, we do, however, apply a lot of effort to engage with these companies,” she adds.
ESG Helps to Avoid Bad Investments
Examining companies from an ESG perspective has enabled Steve Liberator, manager of the Bronze-rated TIAA-CREF Social Choice Bond fund, to avoid a number of problem investments such as Volkswagen, which was downgraded after its emissions scandal, and Well Fargo, which was downgraded amid an accounting scandal. “Ford was another company we did not invest in over ESG concerns,” he adds.
Avoiding the business meant his fund was not impacted when Ford downgraded to below investment grade status and credit spreads on its bonds widened as a result. “Our ESG concerns revolved around the frequency of its product recalls and the associated impact on its free cashflow generation, as well as its ownership structure relative to its peer group.”
But Liberator thinks the fixed income space still has a long way to go in properly incorporating ESG risks into how companies are analysed. He says one of the biggest ESG issues as a bond investor is governance: “You do not want to be invested in an issuer who financial data can’t be trusted.”
He adds: “I expect this will increase and improve rapidly in the next few years in response to investor demand and the recognition of benefits to the investment process.”
