Environmental, social and governance factors (ESG) are not just about saving the planet or feeling good. ESG excellence is a mark of operational and management quality. It means responsiveness to evolving market trends, resilience to regulatory risk, and more engaged and productive employees.
Asset owners focused on sustainable investing can have impact in three ways:
Prevent: Screen out securities that do not align with their values, such as fossil fuels, tobacco or arms makers.
Promote: Focus on companies with strong environmental, social and governance (ESG) track records and integrate ESG factors into the investment process.
Advance: Target outcomes that have a measurable impact on the environment.
Global business and policy leaders take climate change seriously. Extreme weather, natural catastrophes and failure of climate change adaptation ranked among the top 10 global risks in terms of likelihood in 2015 according to a World Economic Forum survey.
Greater transparency on climate risks and exposures will likely lead to a gradual discounting of companies and assets exposed to climate risk – and increase the value of those most resilient to these risks.
SRIF's ESG Approach
We believe that investors can do well (generate performance) while also doing good (have a positive social impact). Often these goals are pitted against one another but we believe that this is a paradox.
Our investment thesis: a company decreasing its environmental, social and governance risks will have a superior return on assets.
This is not just about doing or feeling good. ESG factors cannot be divorced from financial analysis. We view a strong ESG record as a mark of operational and management excellence. Companies that score high on ESG measures tend to quickly adapt to changing environmental and social trends, use resources efficiently, have engaged (and, therefore, productive) employees, and face lower risks of regulatory fines or reputational damage.
Thus, our strategy is as follows:
Avoid losers: Limit exposure to industries that have the heaviest (direct) carbon footprints, such as utilities, materials and energy companies. If climate change regulation picks up steam, these sectors may have to write down assets that have declining or no economic worth (think coal-powered utilities). Successful investment is often as much about avoiding losers as picking winners, in our view.
Names matter: Individual names make a significant difference on ESG portfolio performance, beyond limiting exposure to certain sectors. In other words, certain energy companies are cleaner than others. Some carbon-intensive companies have invested heavily in alternative energy. And the biggest polluters have the greatest scope to reduce future emissions. Many of them will be part of the solution.
Free upside: A low-carbon portfolio can generate similar returns to a conventional index – even if efforts to curb emissions go nowhere, a prominent Swedish pension fund believes. This would mean investors essentially get a free option on carbon: potential upside as markets start to price in carbon risks and some downside protection against loss of capital (a bigger risk to long-term investors than volatility).
Relative performance: Companies decreasing their environmental, social and governance risks should outperform. The relative performance and the rate of change matter, not absolute emissions levels. It is arguably better to focus on the companies that are best in class– even if they happen to be within polluting industries.