How should corporates be thinking about ESG?
To be viewed as ESG friendly with a sustainability focus, a company needs to consider all stakeholders. Management needs to consider the environmental and social impact of their strategic decisions and they need to have good governance practices, and disclose them. They also need to
foster a culture that invites ethical decision making. By doing this, they will likely be more sustainable entities over the long run, thus eliminating risk for stakeholders, especially long-term investors.
What exactly is sustainable investing?
The Global Sustainable Investment Alliance (GSIA) lists seven specific types of investment strategies under the overarching "sustainability" theme. The two most used strategies are negative/exclusionary and ESG integration, with the former being more popular in Europe and the latter being more popular in the US. It is likely that many investors already employ some simple form of integration in their analytical process without defining it as so.
We often hear investors talk about "ESG" stocks, with no attribution to a specific type of sustainability strategy. Care to comment?
This is a label we consider to be applied to companies that have business activities that not only fit into sustainability themed investing such as renewable energy, but also pass exclusionary tests such as those used in materials production, and disclose their sustainability-based efforts and perform well on various ESG scorecards and third party ratings. We don’t think that high ratings by third parties necessarily define an ESG stock, typically we see a correlation. This relationship may change over time as disclosure standardisation improves and investors more routinely rely on their own analysis.
How big is ESG investing?
In the beginning of 2018, European firms making ESG considerations had an estimated ~$14.1 trillion in assets under management (AUM), while US firms were estimated to have ~$12.0 trillion. And, from 2014 to 2018 the level of AUM grew by a CAGR of ~6% and 16% in Europe and the US, respectively.
Do you think investors will think more about ESG?
Yes I believe so. As one investor client we spoke to put it: the buy side is currently trying "to out ESG each other" to attract fund flows. Some are doing it better than others. The early due diligence that the asset allocator community performed around choosing sustainable investment funds involved reviewing investment policies for sustainability mandates and possibly checking to see if an asset manager had made external commitments to their strategy. For example, were they signatories to the UN Principles for Responsible Investing (PRI)? This arguably signalled a commitment to using an ESG framework. In February 2020, an article in the Financial Times highlighted that one out of ten of the PRI's 2000 signatories were on a watch list for failing to meet responsible investing commitments in 2019. Reportedly 50 companies with more than $1 trillion in assets remain on watch.
What is driving increased demand in ESG and forcing asset managers to commit to responsible investing?
There are five main themes driving increased demand. First is corporates’ response to climate change awareness with the World Economic Forum's (WEF) global risk perception survey highlighting the top five risks related to the environment in 2020. Second is the impact of social media and the internet. When a company's business practices have a negative impact on stakeholders, the negative message can be amplified to such a high degree that it may have an impact on the stock price of a company. Third is the rise of artificial intelligence (AI) programs. A number of large investment firms use algorithms to process news flow and other data sets (including social media platforms) to look for positive and negative risk signals. Natural language processing (NLP) programs are becoming more sophisticated and accurate. Fourth is the impact of European regulation and US response. Investors and corporates should not ignore the potential impact of the EU Commission's sustainable finance taxonomy (EU taxonomy), which will require European fund managers to disclose the portion of taxonomy aligned investments in their portfolios by December 31, 2021. And fifth is green financing opportunities and access to cheaper capital.
How do companies choose what to disclose from a sustainability perspective?
The actual process of choosing, collecting, and verifying ESG data is daunting. That said, disclosure topics are typically similar across a sector, but that doesn't always make them comparable or complete. For example, while the data may be verified, one company might present GHG emissions in absolute mtons while another will report an intensity calculation. Social metrics are more cherry picked. To be fair, companies can run into privacy concerns with providing diversity metrics. In some ways, this lack of comparability has contributed to the rise of third party providers, which tout their ability to harmonize the data in addition to highlighting key material ESG risks that they feel may not be addressed.
Debbie Jones is a Director in equity research covering the paper and packaging sector. In 2016, 2017 and 2018 she was runner-up in the Institutional Investor All-America Research poll (4th ranking). In 2014 she was voted as a Rising Star of Wall Street for the paper and packaging sector. Prior to becoming lead analyst, she spent over seven years as part of DB's paper and packaging franchise, helping the team to earn multiple top-three Institutional Investor and Starmine rankings. Ms. Jones first joined Deutsche in 2006 as part of the bank's Graduate Associate Training Program. She obtained her MBA from New York University (Stern) and earned her BA from Claremont McKenna College with a dual major in Psychology and Economics.