“When we talk about ESG in investment management, what are we talking about?” —Georges Serafeim
This question preceded an expert group discussion at the Alpha Summit by CFA Institute last month.
Like Serafeim, Charles M. Williams Professor of Business Administration at Harvard Business School, he explained, capitalism has created enormous wealth and lifted countless people out of poverty. But today it faces two major challenges: climate change and inequality.
“The wealth that has been created has been distributed very, very unequally,” he said. “As a result, many people have been left behind.”
The ESG challenge, then, is to ensure economic prosperity and protect the environment while, in the words of Serafeim, “empowering people to participate in the process of creating economic value”.
So where does ESG analysis stand and how can investors both have impact and invest with impact?
Serafeim and his fellow panelists Melanie AdamsVice President and Head of Corporate Governance and Responsible Investment at RBC Global Asset Management, and CEO of Purview Investments Linda Zhang discussed these and other ESG and sustainable investing issues with the moderator Mary Childs of Silver Planet.
Here are some highlights of their conversation.
Materiality is a powerful force and panelists said focusing on material ESG factors can improve returns. This means that investors should include a materiality lens when making their assessments. But they must also be aware that the prism of materiality differs from one sector to another.
“Materiality means that the ESG factor is going to have an impact on the financial performance of the company,” Adams said. “It depends on the industry. If you look at financial institutions, of course, cybersecurity would be extremely important, maybe not so much for an agribusiness. »
What advantages does materiality bring?
“Elevating the financial materiality of ESG issues is a huge mechanism for change,” Serafeim said. Once something becomes hardware, it gets measured, and C suites and boards get there. For what? Because once it is measured, executive compensation is tied to it. And this is becoming the case with material ESG metrics. This will help investors better manage risks and opportunities.
ESG data still has a long way to go. Reliable and actionable ESG metrics require quality data, and while progress has been made, it just isn’t happening yet.
“The data has improved a lot,” Serafeim said. “But at the same time, it’s not very comparable, it’s not very current. In many cases, there is a lot of noise instead of signal.
Over time, societal-relevant ESG issues will become business-relevant, according to the panelists. Different problems will have different levels of materiality. For example, the carbon emissions profile of the technology sector is not the same as that of other industries. Its products do not produce or use emissions, but its data centers are energy-intensive and staff members can leave a significant carbon footprint when all of their travel is added up.
What about disinvestment? Did the panelists think it was a good idea to weed out or walk away from companies that don’t get the ESG score?
All agreed that engagement is better than divestment and should always be the first step when working with companies. By effectively severing ties, investors have no voice to influence the company. As a starting point, panelists encouraged investors to engage with all of their businesses on their net zero goals.
“We know that fossil fuels will be part of our energy mix probably for the next 10 years,” Adams said. “And so, from our perspective, it’s more valuable for us to be at the table with companies thinking about how they’re going to transition to a low-carbon economy.”
Panelists also emphasized that commitment is not synonymous with acquiescence. Effective engagement requires teeth. Investors should set milestones and benchmarks over time that outline what they expect from companies. Greenwashing is easy: any company can speak up. But if they don’t back this up with concrete action, investors may be putting themselves at undue risk and should be prepared to walk away.
When the discussion turned to the state of disclosure standards, panelists agreed that there is currently a move towards global standards with SASB, IFRSAnd TCFD, among other things, paving the way. However, impact standards are not there yet and are still in their infancy.
For investors to have an impact, they will need to align their portfolios with major global challenges for two reasons, according to the panelists: First, in a human capital-intensive economy, ESG strategies are essential. Second, we are “investment consumers”.
“We can align our consumption with our values,” Serafeim said. “This is another mega trend that I think we’ll see over the next two to three decades.”
The barriers to entry having been lifted, everyone becomes an investor. Currently, more than half of the American population invests. So there’s plenty of opportunity to pick titles with where we want the world to go in mind. If we want to address climate risk, protect biodiversity or reduce inequality, we need to invest in this way. ESG is strategically relevant, and to be competitive, companies need to address all three areas. As investors, we can help get that message across.
To mitigate climate change, carbon offsets can be a useful tool.
“Many companies adopt both active emission reduction, waste reduction, utilization efficiency improvement and credit purchase,” Zhang observed. “The first and largest credit market where you can trade emissions allowances is in Europe, isn’t it? If you look at the price of emissions per metric ton of CO2at the beginning of the year, the price was $36 or $38, and now it exceeds $56.
But again, the nature of the data matters. Companies should review the quality of offsets, to ensure they are audited and retired. It’s hard to achieve goals without doing both.
So what advice did the panelists have for those looking to enter the field of impact investing?
A key recommendation is to direct your career to where the growth is going to be. Climate change and the threat of it will alter the economy over the coming decades. Some sectors will be completely disrupted, and where there is disruption is where the alpha opportunity exists. It will be an exciting environment, but passion alone will not be enough to succeed. Success will require technical skills.
But these technical skills can take many forms. ESG and sustainable investing are not a single environment.
“One of the biggest things I think about is how broad the ESG space is, how many different metrics there are, and we’re very focused right now on climate change,” Adams observed. “But there are also other ESG metrics that we need to focus on as well.”
She pointed to cybersecurity as a key consideration that has only recently begun to receive the attention it deserves. And Adams emphasized the importance of getting the third letter right.
“You just can’t manage your E&O properly if you don’t have proper governance in place,” she said.
As a group however, the panel struck a hopeful and optimistic tone despite the challenges.
“Humanity is facing an incredible opportunity right now,” Zhang observed. “We’re on the cusp of a new industrial revolution, aren’t we, and this one just happens to be green.”
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
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