PLACE FINANCIÈRE & MARCHÉS — Fonds

Contribution - Alfi

The Sustainable investing journey



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Sachin Vankalas, general manager chez LuxFLAG. (Photo: LuxFLAG)

Sustainable investments have grown by 34 percent to $30.7 trillion since 2016, mainly contributed by institutional clients (pension funds), retail investors and growing public and political concern about climate change.

Regulatory and policy developments, such as the EU action plan on financing sustainable growth and following the three legislative proposals, have significantly contributed to raising awareness about this topic. Europe firmly remains in the lead for sustainable investments with about $14 trillion devoted to these strategies, up 11 percent from 2016, according to the Global Sustainable Investment Alliance, which aggregates data from regional sustainable investment associations/forums around the world.

Sustainable investing, which was broadly understood as “avoiding/eliminating exposures to companies or sectors that pose certain risks or violate the investor’s values” only two decades ago, has evolved over time into a sophisticated investment phenomenon which “systematically considers Environmental, Social and Governance (ESG) factors in portfolio selection and management” in order to advance on certain desired ESG outcomes and financial returns.

Most investors still have difficulties in differentiating between so-called “impact investing” and ESG-related issues. In many cases, these two terms are misplaced.

What is “impact investing”?

There are various definitions of impact investing – most of the time understood as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. These investments could be typically made in any of the 17 sustainable development goals (water, food security, health and well-being, education, financial inclusion, future mobility, circular economy, energy transition, and impact enablers).

This is different from ESG, which focuses on integrating Environmental, Social and Governance factors into the investment process in order to make informed decisions. “ESG investing” is therefore investing in companies with good ESG practises.

Impact investing focuses on a company’s activity or services whereas ESG focuses more on how a company operates.

The strategic importance of ESG issues may vary by company and sector. For example, a company involved in mining may have a higher likelihood to be exposed to ESG issues than a company in the service industry. In the past, a glossy Corporate Social Responsibility (CSR) with exaggerated claims and amplified pictures on “how good we are” was considered a job done. However, the increasing investor scrutiny on ESG issues has pushed companies to a higher level of corporate transparency. Over a short period, more than 50% of global companies are reporting on their sustainability, including their performance related to ESG factors. As a result of this, there has been a wide consensus on poor ESG practises or ignoring ESG issues that pose legal and reputational risks, which can consequently damage the company’s ability to attract more investments.

Does ESG pose a threat of significantly limiting investment universe for conscious investors?
Sachin Vankalas

Sachin Vankalas,  general manager,  LuxFLAG

ESG-related data are improving, but still remain inconsistent. Some subcomponents of ESG ratings are more useful than others depending on the company’s activity and sector, e.g. while evaluating a financial services firm, the ESG subcomponent on customer data protection would matter more than their natural resource use policy. Therefore, aggregating those subcomponents into a simple headline score may be misleading.

Numerous ESG data vendors have established benchmarks and tools on ESG risk and performance, which are well accepted by the investors in public markets. Though sufficient data are made available for listed companies, it also adds complexity as the data vendors use different methodologies, e.g. in the midst of a big scandal a German car manufacturer was rated “positive” by one ESG data vendor, but “negative” by another. In private markets, however, ESG disclosure remains limited.

Does ESG pose a threat of significantly limiting investment universe for conscious investors? For the time being, it does to a certain extent, but this is only a matter of time. Today, if one is a reasonable size asset manager or investor, one can simply not afford to be ignorant of ESG. The same will apply to companies as well.

More news on the fund industry in  Paperjam’s Alfi  supplement.