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July 14, 2020

Sustainable Investment: A toolkit for investors

  Olivier Goemans myINVEST March 25, 2020 31

Short-termism has been widely identified as a common negative side-effect from financial markets, resulting in “underinvestment, economic inefficiency and poor decision-making, undermining long-term value creation”1. It is also widely recognised that today’s financial system does not actively promote long-term thinking.

When speaking about the investment horizon, a classical perspective comes into mind: speculating (short-term) vs. investing (long-term). Our role is not to pour moral scorn on the first category, but as investment advisors or portfolio managers, we have a duty to help clients navigate, for instance, the stock markets as a “warehouse of cash-flows, not a casino”2.

For us long-term investing is a state of mind. It is not a predefined holding period, written in stone. It is basically a culture of making investment decisions based on sound and viable dimensions. It gives emphasis to long term expectations on fundamental factors and reaps the rewards of patience. It is less about timeframe and more about alignment to structural trends and challenges.

It is our conviction that when discussing structural trends, climate change should be at forefront of priorities.

Embedding resilience and mitigating environmental risk should, as well, become a routine part of any investment decisions.

Traditional fundamental analysis is about routinely scrutinizing upside financial opportunities and downside risks. But this is clearly not enough anymore. From our perspective, embedding ESG factors in order to measure resilience and incorporate environmental risk should, as well, become a routine part of any investment decision.

Broadly speaking, growing awareness of the sustainability agenda is clearly visible inside the investment community. According to the Harvard Business Review, we are currently facing an “Investor Revolution”3 in relation to sustainable investment. While market experts are debating the history of sustainable investment, the factors driving the portfolio management industry (sustainability) revolution and its impact on past performances, we would like to describe some of the crucial requirements when looking for investment service providers in relation to sustainable ambitions.

To translate these words into action, the starting point is the establishment of investment beliefs and associated sustainability convictions. Investment beliefs are the views held by the portfolio management institution. They represent explicit assumptions an institution makes about how it should invest and the principles it follows as a result.

To illustrate, a classical set of investment beliefs could reflect one or more of the following:

  • Long-termism in financial markets is conducive to long-term value creation
  • Short-termism in financial markets is creating unwanted externalities that may harm returns
  • Sustainable investment is the cornerstone of a portfolio manager’s fiduciary duty
  • Certain ESG issues represent long term systemic risks
  • Certain ESG trends and momentum represent long term investment opportunities
  • A commitment to stewardship adds value to investments
  • By engaging with different stakeholders, investors can enhance their risk/return profile.

Integrating ESG data into the investment decision-making process as well as pursuing active stewardship engagement with issuers, is key in proposing long-term responsible and sustainable investment solutions.

When it becomes clear that investors have internalized ESG into their calculations, the business leaders will be forced to do the same within their companies.

On ESG integration, the attention point is related to materiality or to identify “material” ESG issues that impact a firm’s valuation. Materiality varies by sector and industry. For example, greenhouse gas emissions are material for a utility company but not for a financial services firm; supply chain management is material for an industrial company using low-cost workers in developing countries but not for a pharmaceutical company. In a nutshell, portfolio managers should be accountable for assessing every investment in the context of risk, return, costs, and ESG. By doing so, it feeds as positive feedback loop. When it becomes clear that the people who decide whether to buy or sell a company’s stock have internalized ESG into their calculations, the business leaders will be forced to do the same within their companies.

Within the portfolio management organization, a strong culture of teamwork and learning from mistakes is key. Golden rules on sustainable investment don’t exist. The journey to SRI is a bumpy road paved with uncertainties. No one-size-fits-all integration process exists. A disciplined, but agile, investment process is crucial.

Demonstrable, supportive leadership from senior levels is also needed in order to create a culture in which responsible and sustainable investment is a concrete and actionable ambition.

Investors should be expected to conduct regular dialogue with companies they invest in, focusing on long-term dimensions and facilitating disclosures. Doing so create an incentive for companies to address materiality issues that should improve their financial robustness and competitive positioning. Addressing GHG emission and carbon footprint disclosures is an example of collective “irresistible force pressing on the immovable object4” of the larger CO2 emitters.

Finally, portfolio managers should also be able to demonstrate what actions were taken to promote sustainable business practices. Some indicators of best practices company engagement could be:

  • Public information about engagement policy
  • Record keeping of engagement activities, including objectives and outcomes
  • Voting rights: exerce details, processes and coverage

Here are some key takeaway when selecting a sustainable investment solution provider:

  • Investment beliefs and processes should demonstrate a deep consideration for sustainability factors
  • Team capability and engagement to sustainable finance is predominant versus team size
  • The investment service provider should be able to demonstrate how ESG is fully integrated and ‘grows from within’ the process organically, rather than being ‘inserted from outside’
  • The investment service provider should be able to demonstrate how ESG issues are considered having materiality impacts
  • A humble and nimble culture of learning-by-doing and learning from mistakes is advantageous
  • Transparent reporting on the sustainability journey and the sustainability characteristics of the investments should be available
  • Reporting by investment service providers should demonstrate how sustainability is embedded within the investment process, explain stewardship activities and illustrate the outcomes of stewardship

1 The Kay review of UK equity markets and long-term decision making
2 Investors Chronicle – What kind of investors are you”https://www.investorschronicle.co.uk/2014/04/04/comment/chronic-investor-blog/what-kind-of-investor-are-you-Uy4i2nR85ZNzLTJ6LjjVgK/article.html
3 Harvard Business Review June 2019: The Investor Revolution  https://hbr.org/2019/05/the-investor-revolution
4 Anne Simpson, head of strategy at CalPERS in Harvard Business Review June 2019