In 2018, it was reported that ESG accounted for around a quarter of all professionally managed assets globally, and with the powerful combination of government regulation and consumer demand pushing the movement forward, this figure is likely to rise.
But while ESG might be relatively fresh on the radar for advisers, Ashley Hamilton-Claxton, Head of Responsible Investment at Royal London Asset Management (RLAM), explains that ESG has long been part of their decision-making process. “In reality we have been applying ESG factors, along with lots of other material factors, to investment portfolios for years,” she says, “but the Department for Work and Pensions’ requirement for trustees to include their ESG approach within their statement of investment principles (SIP) has been a catalyst for change, forcing the issue to the top of the agenda.
Take the energy sector as an example; analysts have been thinking about the concept of stranded assets for years, but have not been taking serious steps to get out of these potentially unsustainable assets. The noise around ESG has nudged managers to take more concrete steps to consider the companies they hold in the context of ESG risks or opportunities, and to make adjustments.”
Asset managers at RLAM have been taking such steps, with managers on the Sterling Credit Fund – held within the Governed Range - recently undertaking a deep dive into the UK gas sector. “The fund holds bonds of several utilities including gas, but with the UK government committing to a legally binding target of net zero carbon emissions by 2050, it’s clear some utilities have better future prospects than others. There’s a perception in the credit market that utilities are relatively stable assets and therefore low risk, but our analysis showed us that some gas businesses could become stranded assets in the future, and that we could get the same yield from electricity utilities that don’t face the same long-term sustainability risk.”
In order to analyse an investment opportunity, asset managers rely on ESG data – of which there is an increasing volume. There’s been a rapid rise in the number of providers and amount of data available, but while this data is informative, it’s no substitute for expert evaluation.
“Deeper internal analysis and expertise is needed,” says Ashley. “The nature of ESG data is changing rapidly, with new data providers doing real-time scoring of companies - but off-the-shelf data is no substitute for deep analysis by an active manager. Going back to the gas utility example – we could not have made the call we did on the basis of off-the-shelf ESG data. This is partly because providers tend not to have much ESG data on private or semi-public organisations such as utilities, and it’s also partly because a manager can only make a call after doing a lot of deep thinking about the issues and talking to the companies themselves.”
Extensive industry data has shown that taking an ESG approach results in either a positive or neutral impact on performance.
However, it’s important to point out that that integrating ESG is not about choosing values over value, but about analysing the opportunity to provide the best possible outcomes whilst encouraging businesses to act in a responsible way. According to Ashley, it’s too simplistic to discriminate between ‘moral’ risks and pure financial risks. For example, a tobacco company may rank highly on ESG due to employment practices or soil management, even though the end-product it creates is harmful. “If an investor or trustee wants to exclude investments in tobacco across the board, that would be an ethical or ‘exclusions’ approach, not an ESG one.”
So when it comes to approach, how can advisers know if a fund is operating a genuinely robust ESG process?
“There’s a lot of confusion about definitions and terminology, so advisers need to lift the lid and look under the bonnet to see what the fund is actually doing on ESG,” says Ashley. “Unfortunately it is not enough to simply look at the fund’s name – this will not always reflect what a fund actually does on ESG. Adopting ESG is not about putting a marketing wrapper around a product you already have; it requires a deep understanding of ESG issues and changes in systems and processes to ensure that these factors are genuinely part of the investment process.”