A flippant, fearless, and fundamental countdown of big money investing.

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Art by Chris Buzelli

#33 ESG

ESG’s Image Problem

A typical discussion among current (and former) CIO editors on our coverage of environmental, social, and governance (ESG) issues tends to pan out like this.

Kip McDaniel: “I just don’t believe asset owners can save the world.”

Nick Reeve: “Well don’t blame me when a polar bear floats past your third-floor apartment window.”

Leanna Orr: “You’re a tree-hugger, Reeve.”

Clearly, ESG investing has an image problem. How to persuade a couple of stubborn Canadians that ESG risks are not just about eating vegan and wearing sandals? (For the record, I don’t do either of those things.)

For one, data: Investors responsible for trillions of dollars have backed major studies showing how asset owners and managers can be affected—and how they can address—climate change risk. Mercer’s report, “Investing in a Time of Climate Change,” published last year, garnered the support of New Zealand Super, the California State Teachers’ Retirement System (CalSTRS), New York State Common Retirement Fund, and Sweden’s AP1, among others.

In December, AP4 CEO Mats Andersson announced to an audience of investors, business leaders, and policymakers at the COP-21 summit in Paris that investors representing more than $600 billion had signed up to the Portfolio Decarbonization Coalition, which aims to reduce the carbon output of its members’ portfolios while maintaining returns.

However, the same asset owner names have appeared on subsequent reports and campaigns. Are the advocates of ESG preaching to the converted?

“There is a lot of terminology, and it’s hard to navigate,” says Garrett Wilson, investment specialist at outsourced-CIO Hirtle Callaghan. It’s easy to see what he means—there is an alphabet soup of acronyms for what is essentially the same thing. We have ESG, SRI (socially responsible investing), and CSR (corporate social responsibility). Then there is impact investing, screening (positive or negative), and the worst one, ‘responsible investing’—the ESG world’s equivalent of ‘solutions.’

“It’s difficult at an investment committee level to understand how to represent ESG across the portfolio,” Wilson continues. “It’s much bigger than negative screening. It’s about assessing environmental risk; it could involve identifying labor practices that could be material to the company. It’s much wider than morals and values.”

Wilson gives the example of an integrated oil and gas company. Regardless of the politics of the climate change debate, investors must ask how such a company is preparing for new climate-related regulation promised by policymakers at the COP-21 summit. “I see it [ESG] as proactive investing for people who wish to analyze all the underlying risks,” he adds.

Asset owners, managers, and consultants are desperate to move the conversation beyond the green, do-gooder reputation and into the realm of long-term risk management. “As asset owners with long-term time horizons, we are most exposed to long-term issues,” says Karianne Lancee, senior pension investments and sustainability manager at Univest, which manages Unilever’s global pension funds. “If we need to pay investors over the long term, we need a sustainable economy.”

Addressing climate change is just part of a long-term risk management policy—and, as Lancee argues, one of the easier parts. “Climate change is the low-hanging fruit, and you can reduce a lot of risk right now,” she says. In an effort to broaden the risks Unilever manages, the group has not adopted a specific climate change policy, instead choosing to address a much wider set of issues.

Hirtle Callaghan’s Wilson returns to his example, highlighting labor policies at companies as a risk that can “impair the future cash flows” equity investors seek. “These are material issues,” he adds, and they require more than just box-ticking.

At Sweden’s AP4, alongside CEO Andersson’s vocal stance on climate change action, the fund has put money into impact investing projects addressing sustainable water and child welfare issues. 

The consensus: If you’re serious about managing the long-term risks to your portfolio, ESG issues matter. Perhaps we should just stop using the stale jargon.

In an interview with the Daily Telegraph in 2000, Sheikh Ahmed Zaki Yamani—Saudi Arabia’s former oil minister—emphasized succinctly the need for a long-term view: “Thirty years from now there will be a huge amount of oil—and no buyers. The Stone Age didn’t end for lack of stone, and the oil age will end long before the world runs out of oil.” Time to stop hugging those trees.

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