ESG Investing – Poetry in Motion

The absence of globally accepted environmental, social, governance (ESG) standards has not detracted from the rapid growth in ESG fund inflows. However, data driven evidence of “walking the walk” are key components to building and retaining credibility in the ESG arena.

Ireland was long referred to as the “land of saints and scholars” and although it has greatly modernized, it remains fertile ground for poets, authors, artists, and playwrights. Storytelling is a national pastime, as anyone who has frequented an Irish pub can attest. Today, many asset managers are attempting to convey their current and future journey towards sustainability – investors and asset owners are left to figure out fact from fiction.

Global asset management is currently absorbed in defining common ESG standards. For ESG investing to flourish, the industry must strike a balance between setting uniform screening standards whilst allowing firms to retain an adequate degree of investment flexibility. Practical obstacles remain in implementing ESG policies across the industry, including stakeholder access to high-quality data. For now, much ESG data is self-reported, so it isn’t audited or independently verified. The success of ESG depends on the right blend of clear, objective rules and regulations while still affording asset managers an acceptable degree of poetic licence when it comes to investment choices.

However, regulators and policymakers currently find themselves in a quandary. If ESG rules are framed in an overly prescriptive fashion, it could become more difficult for managers to fulfil their investment mandates and uphold their fiduciary duties to clients. However, absence of prescription leads to grey area and investors aren’t keen on grey area. Some worry that asset managers may talk of ESG integration, without putting it into action – a practice known as “green washing.” In lieu of common global standards, it is difficult to compare ESG products. If rules are overly stringent, ESG strategies may become constrained thus reducing returns and disappointing investors.

Using some poetic licence of my own, here are ESG principles fundamental to capitalizing on this growing theme, accompanied by sage words from a few of Ireland’s greatest ‎wordsmiths:

“In dreams begins responsibilities” – W.B. Yeats

At the start of 2018, Blackrock’s Larry Fink threw down the gauntlet to ‎the global asset management industry when he published his “Sense of Purpose” CEO letter. This letter was met with varying degrees of praise and cynicism. Regardless, it placed the question of sustainability at the centre of asset management and the debate has only ramped up in the proceeding months. If asset managers wish to remain trusted in the public’s consciousness, they must show strong commitment to issues such as stewardship, ethics, the environment, diversity, and sustainability of the industry over short termism and profit. ESG marks an opportunity for asset managers to reconnect with both existing and future investors.

Much current industry research points to investors wanting their investments to match in some way their own personal value systems.  There is growing evidence also that investors are willing to pay a premium to providers willing to match investment products to their values.

Oscare Wilde

“The pure and simple truth is rarely pure and never simple” – Oscar Wilde

‎The primary challenge remains forming global consensus on ESG standards and taxonomy to frame universally accepted rules. Such accord will increase confidence, understanding, and comparability of ESG labelled products in the market. The existing fragmentation of standards remains a small anchor to the growth of ESG asset management. When investors can accurately pit one ESG product against another, competition and demand can increase in the space.

“A man is original when he speaks the truth, that has always been known to all good men” – Patrick Kavanagh

Transparency is a key element of proving ESG lies at the core of a business. Firms need to be held accountable when they claim to commit to ESG. Those who tell tales risk being left behind as ESG continues to rise as a defining decision-making factor for investors. Touting ESG plans and not following through or committing wholeheartedly can also pose reputational risk for asset managers trying to keep up in the space. Data is a crucial component to providing that transparency.

Some recent high-profile missteps resulted in considerable damage to corporate valuations (e.g.: Uber, Equifax, Facebook). Negative portfolio screening remains important, however is a slightly dated approach as the industry has moved to assessing companies on positive ESG elements with a view to rewarding and investing in companies which show behaviour indicative of a sustainable business model.

“We were always loyal to lost causes; success for us is the dark of the intellect and of the imagination” – James Joyce

As the industry continues to work towards framing globally accepted definitions and standards, there is an increasing body of evidence that integrating ESG parameters in the risk and investment process could lead to portfolio outperformance. Investors are rewarding further ESG integration with ever increasing inflows. This macro trend seems unlikely to abate any time soon.

More and more modern-day investors categorically reject economist Milton Friedman’s declaration that the only social responsibility a company has is to increase its profits and regulators are taking notice. The EU’s Shareholder Rights Directive, the SEC’s Regulation Best Interest in the US, and components of the UK’s Senior Management and Certification Regime (SM&CR) puts an onus on asset managers to deal with issues pertaining to ethics, sustainability, and culture.

On a related note, Carla Jane Findlay-Dons, BBH’s Chief Global Regulatory and Market Strategist, and I will be continuing the ESG conversation this week at the European Sustainable Investment Summit in London. If you’re attending the summit, we look forward to meeting you. If not, you can follow Carla Jane on Twitter @CarlaJaneBBH for conference insights.

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