Sustainable Investing Opinion Briefs: October 1 – October 15, 2018

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Oct. 13, 2018 – An article by Eshe Nelson in Quartz entitled “Why sustainable investing won’t be mainstream for a very long time” posits that new ESG benchmarks are required to facilitate ESG investing and transform this from a side business to mainstream.  The author reports that new stock indexes are being created by such firms as S&P and MSCI that use data from firms such as Sustainalytics and Equileap, however, new indexes are required because the “world’s benchmark indexes don’t incorporate social responsibility criteria.“  Besides conflating ESG integration with its focus on risks and opportunities and social responsible investing that relies on a values based approach and exclusionary practices, the direct linkage that the author draws between growth in ESG investing and changes to benchmark indexes is likely misplaced. The availability of additional ESG indexes could lead to the creation of additional passively managed products and asset gathering but these could also lead to further confusion in the absence of educational efforts on the part of the investment management community.  More importantly, the outcomes associated with active investing strategies that account for relevant and material ESG risks and opportunities, just like any other quantitative and qualitative factors, should, in our opinion, be subject to an objective evaluation relative to standard securities market indexes.

Oct. 12, 2018 – A report by the Urban Land Institute cited in the National Real Estate Investor highlights the growing “attention to ESG issues” in REITs.  The report entitled “Emerging Trends in Real Estate” states that pressure on REITs to focus on ESG issues has become “imperative.”  This pressure is coming from institutional investors in REITs where one-in-four currently “employ some sort of ESG screening methods when picking investments.”  In part, investors see ESG factors as “promoting resiliency for REITs” and their underlying assets. It is encouraging that the real estate development business is catching the sustainability wave – property developers aren’t known for their sensitivity to open space and the environment – but the sheer size of the asset class offer potential.

Oct. 9, 2018 – A study by Cerulli as reported in ThinkAdvisor concludes that “Many Advisors Avoid ESG Strategies Despite Investor Interest.” Advisors are also concluded to be “slow to adopt” sustainable investments even as more offerings become available.  Cerulli reports that only 33% of advisors used “ESG strategies in 2017”.  The main reason being that advisors “fear such strategies will negatively impact performance,” in spite of 46% of investor households and 60% of investors under 39 years old, preferring ESG approaches. We think that performance is clearly not the whole story behind advisors being less receptive to ESG strategies.  First, ESG fund performance records are less than complete. More likely, some advisors find easier sales for a variety of reasons with non-ESG funds.

Oct. 1, 2018 – An article by Jassmyn Goh in Portfolio Advisor, “ESG Investing Needs an Intellectual Boost, “ finds that some feel the asset management industry needs to go beyond viewing sustainable investing as simply tracking an index.  For instance, Robert de Guige of Lombard Odie feels that some exclusionary approaches “delegate all the methodology” of sustainable investing to “someone else,” and without a manager’s own input, sustainable funds risk becoming simply marketing.   Taken to the next step, Ana Harris of State Street suggests that “self-regulating ESG disclosure” may be needed to lessen this marketing tilt. We agree and further believe that fund companies need to err on the side of caution when promoting and offering sustainable products.  After all they are selling to their clients “values” with these funds.

Sept. 28, 2018 – Schroder’s “Global Investor Study 2018” finds that 3/4ths of respondents say that sustainable investing “has become more important to them in the last five years.”  The survey, as reported by Beth Brearly in Professional Adviser, also finds that fully 83% of retail investors between the ages of 18 and 44 say that sustainable investing is more important today, while 66% of those 45 years old and older agree. Survey respondents are investing an average of 37% of their entire portfolios in sustainable investments. We think that while ESG fund cash flows don’t appear to support this investing trend on the part of retail investors at present, these findings show sustainable investing is gaining share of mind.  What remains to be seen though, is whether this trend will persist when the market contacts – education and new sustainable down-market products may be the answers.

Sept. 28, 2018 – A study of private bank advisors in Europe finds that they lag when it comes to offering their clients sustainable investments.  The study conducted by the University of Zurich, found variations among banks, but concludes that European “banks’ products fall short where there might be the largest interest and impact for investors … even though private clients often are interested in sustainable products.” Contributing to this is that “relationship managers lack of training in sustainable investments.” We see these findings as revealing given these institutions’ tradition and reputation for personalized services.  It also suggests that simply the presence of a client relationship does not compensate for product knowledge.

Sept. 19/24, 2018 – The continued expansion and widening reach of explicit ESG integration was recently illustrated yet again when both Moody’s Investors Service and S&P Global Ratings, the two largest credit rating agencies, issued, within days of each other, proposed ESG methodologies applicable to fixed income instruments.  That said, the proposed methodologies take very different approaches to the evaluation of environmental, social and governance (ESG) risks and opportunities.  It should be noted that Moody’s and S&P have been accounting for ESG risks when these have been deemed relevant and material to the assessment of creditworthiness, i.e. an issuer’s likelihood to default.  Even as the two rating agencies have stepped up their research and analysis into these areas in recent years, such considerations may not have been entirely transparent nor were the approaches to integrating ESG applied consistently and systematically in the past.  Also, the firm’s may have been referring to related risks using different terminology.  In the case of Moody’s, the proposed methodology applies to all types of fixed income instruments, ranging from corporate bonds to municipal bonds, to sovereigns and structured finance transactions.  Further, ESG factors will be imbedded into Moody’s credit rating methodologies and credit assessments.  In its “General Principles for Assessing Environmental, Social and Governance Risks” issued September 19, Moody’s sets out a broad conceptual framework to consider current or developing ESG issues that can affect credit quality for issuers and transactions in all sectors. Moody’s notes that “ESG incorporates concepts that are complex, evolving and multifaceted. Environmental science is continually evolving. Market definitions of social and governance considerations are not standardized, and the issues themselves are dynamic. Reporting around ESG issues is neither systematic nor standardized. Nonetheless, ESG considerations are highly relevant to investors and issuers, and we think it is important to advance the transparency of ESG considerations in our analysis.”

S&P, on the other hand, seems to be applying its methodology more narrowly to corporations and other entities. The firm intends to produce a separate stand-alone ESG Evaluation that is not directly linked to the firm’s credit ratings.  As set forth in “S&P Global Ratings’ Proposal for Environmental, Social And Governance (ESG Evaluations” dated September 24, the ESG Evaluation, which has to be requested, is a cross-sector, relative analysis of an entity’s ability to operate successfully in the future and optimize long-term stakeholder value in light of its natural and social environment and the quality of its governance. S&P’s process starts with an ESG Profile for a given entity, which assesses the exposure of an entity’s operations to observable ESG risks and opportunities, taking account of the governance structure in mitigating risks and capitalizing on opportunities.  Second, S&P intends to assess an entity’s long-term Preparedness, namely its capacity to anticipate and adapt to a variety of long-term plausible disruptions. Such disruptions are not limited to environmental and social scenarios, but could also include technological or political changes where relevant. Finally, an ESG Evaluation score combines an entity’s ESG Profile with the long-term Preparedness assessment, thereby indicating S&P’s view of how effectively the entity is set up to manage its ESG exposure and opportunities.

We believe that stepping up the rating agencies’ efforts to weigh in with their ESG approaches applied to credit instruments in a consistent and systematic manner will add a desired level of transparency to a large segment of the capital markets. These efforts will also serve to advance the debate around ESG terms and definitions.

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