Full integration of Environmental, Social and Governance (ESG) factors has strong momentum among institutional investors, and collecting data on ESG investment strategies is becoming the norm.
That’s according to CleanTechIQ’s webinar, Actionable Opportunities for ESG & Impact Strategies in Public Equities on May 9.
About 70% of investors are now seeking reporting on ESG risks as well as on environmental impact metrics on portfolios. And 40% are integrating ESG factors across their entire portfolios, according to audience polls taken during the webinar.
According to panelist Noelle Laing, managing director at investment consultant Cambridge Associates, ESG factors pertain to the impact a public company is having on its stakeholders, including its customers, employees, communities and the environment. Incorporating these factors into the investment process is also called “sustainable investing.”
Asset owners increasingly believe that ESG factors are material to a stock’s financial performance. These factors can cover a broad range to include a company’s greenhouse gas emissions and water usage, how it handles its waste, how it treats its employees, its product safety record and the independence of its board, according to Laing.
Climate risk is a growing issue of concern for institutional investors as they become more aware of ESG-related risks that are present in their portfolios. This is driven by the fact that there’s a better understanding that ESG risks are material to the financial performance of companies and their portfolios, Laing notes.
In fact, Impax Asset Management finds that public companies that are rated higher on an ESG basis have better investment returns than lower-rated companies. This has driven the firm to incorporate proprietary ESG research into its investment process, said panelist David Richardson, an executive director at the $8 billion money manager.
Providing ESG impact data to investors is no longer optional for managers, Richardson says. Impax finds that, since this data is increasingly important to asset owners, companies are starting to provide greater disclosure, but there’s still a long way to go before investors can rely on publicly disclosed ESG data.
Environmental Impact Data Challenges
In any case, institutional investors are showing increasing interest in understanding the carbon footprint of companies in their portfolios, the webinar panelists agreed.
However, there are problems with calculating a “gross carbon footprint,” because the data provided by the companies themselves is lacking and inconsistent, Richardson says. In fact, few companies are providing the level of detail required to understand their environmental impact, even though most ESG screens currently use publicly available data.
This has driven Impax to undertake a proprietary “Net CO2 Emission Footprint” analysis, which measures the CO2 emissions avoidance, or carbon reduction, that a company’s product or service generates. Impax feels this is a more relevant metric to understand a company’s CO2 impact than relying only on gross carbon footprint.
Impax also generates proprietary data for its investors on water saved or treated, renewable energy generated and waste recovered across its portfolio.
This proprietary ESG research also helps investors understand material ESG issues and risks for each company, which differ by sector and the activity each company is involved in as well as by region, says Richardson.
Building an ESG Portfolio
Cambridge sees its clients undertaking various ESG implementation strategies:
Opportunistic deployment: selecting investments on a case-by-case basis, to add diversification to portfolios. Laing sees this strategy being applied across Cambridge’s client base.
Carve-out approach: a portion of a portfolio is put into impact investments. This approach offers flexibility as there is less pressure to find investments that conform to the overall portfolio goals.
Full ESG integration: investors seeking to align their investments with their mission, an approach that is gaining traction with family offices and foundations.
The growing number of investment products across the risk spectrum is making full integration increasingly possible.
Cambridge now tracks 543 asset managers and 1,000 investment products in their ESG and sustainable investment universe, which represents only a small fraction of their total manager database. That, Laing says, indicates that there are still major opportunities for asset managers to launch sustainable investing products.
The current ESG universe is made up mostly of negatively screened products, so there’s an opportunity for managers to offer fully integrated ESG portfolios. Furthermore, although there is an overall trend towards the use of passive strategies, new actively managed separately managed account products will be necessary for investors seeking to invest around their beliefs.
Key ESG Growth Drivers
The growth of ESG is no longer being driven solely by fossil fuel divestiture and the desire for “green” portfolios. Just as important now is the fact that investors are seeing growing investment opportunities brought about by the transition to a low carbon economy, our panelists say.
These new investment opportunities are in areas including water and wastewater treatment, resource recovery, clean energy, energy efficiency and sustainable agriculture. Impax believes these areas are becoming sources of sustainable growth for economies worldwide as well as providing solutions to growing issues arising from resource scarcity.
From the asset manager perspective, the key challenge is related to corporate disclosure of ESG data.
Although there’s a growing amount of third-party ESG data becoming available and driving the emergence of a cottage industry, the onus is still on the portfolio manager themselves to develop propriety ESG analysis of companies and to identify what information is material to a company’s financial performance and its risks over the long-term.
To hear a replay of the webinar, click here.