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Integrating ESG into capital allocation and investment strategy is ‘simply good investing’

Integrating ESG into capital allocation and investment strategy is ‘simply good investing’

With wildfires, the Covid-19 pandemic, the strengthening Black Lives Matter movement and the Yemen crisis dominating headlines in 2020, the sustainable investing space has seen demand despite the IMF’s projection that global growth will fall by 3% this year, resulting in the worst recession since the Great Depression and consequences far worse than the global financial crisis.

Finextra Research spoke to Claudia Coppenolle, co-founder and CEO of the IMP+ACT Alliance, a Deutsche Bank spin off, public good technology initiative and developer of the IMP+ACT Classification System (ICS), about how these global events will effect investment strategies, not only in the sustainable investing space, but asset management in a holistic manner.

Launching in June 2020, the ICS will enable asset managers to describe how they report and categorise the social and environmental impacts of their investment portfolios. With this, asset owners can receive, assess and compare impact performance information in a transparent and consistent format to inform capital allocation in support of the UN’s Sustainable Development Goals.

Bank intrapreneur turned entrepreneur Coppenolle highlights that in these unprecedented times, digital processes such as the ICS are of paramount importance when attempting to understand the financial and non-financial implications that sudden shocks to the market have on investment portfolios.

Further, benefit from consistent information on types of impact occurring across entire multi-asset class portfolios, even when asset managers are using different measurement and rating techniques.

The future of sustainable investing, post-lockdown

Coppenolle elucidates that as the world moves into a post-lockdown mode while managing increasing social unrest, the need for more transparency on how organisations manage not only the 'E' of ESG, but also the 'S' and 'G' factors has surfaced. “The conversations that need to happen around how to create more inclusive communities and societies are happening. The pandemic and the Black Lives Matter protests have definitely created heightened awareness around these factors and these need to be more broadly addressed and monitored.”

This is a good starting point when considering ethical or sustainable investment, Coppenolle says. A common misconception permeates in the investment space, where many believe that a specific strategy is required and that the motivation to manage ESG impact is driven solely by philanthropic desire.

While some investors and asset owners may want to make a positive change, others may use ESG factors to understand commercial opportunities by investing in companies that are able to cut costs by saving energy or managing their carbon emissions.

However, all investments have a positive and a negative impact. “The minute you invest, you will have an impact on people, the planet and the economy.”

As this sentiment is increasingly understood, there is also a need for greater education about the financial implications that some ethical, social and governance (ESG) or sustainability factors have on investment portfolios.

“While some try to distinguish mainstream investing from sustainable investing, integrating ESG factors into capital allocation decisions and investment strategies is simply good investing.” She adds that by considering, measuring and reporting ESG factors in a transparent fashion, organisations can also start to manage and reduce regulatory and reputational risk long term.

Inclusive growth in a circular economy

While the sudden shock to market has created a greater understanding about the financial implications of sustainability factors on portfolios, it must also be understood that climate risk in a portfolio is not only an environmental issue, it can be a substantial material financial risk like any other.

Financial risk can be mitigated, as evidenced by investments that were heavily exposed and underperformed in some ESG-aligned counterparts. Coppenolle explains that managers of sustainable funds have long said that using ESG factors can limit risks in their portfolios.

“The market observed better risk-adjusted performance across sustainable products globally and a Bloomberg analysis revealed that the average ESG fund has seen its price fall by half the decrease registered by the S&P 500 Index over the same period during the Covid-19 crisis,” she said.

Coppenolle goes on to say that a possible explanation could be that “ESG portfolios are often heavily invested in technology and health-care stocks and they typically have very limited, if no exposure to fossil-fuel companies, which were heavily hit by the plunging oil price.

“They also tend to exclude heavy-polluting companies such as airlines, which have suffered a drastic decline in business and thereby profitability due to ongoing travel restrictions.”

Perceiving investment as a circular economy, a system aimed at eliminating waste and the continual use of resources is burgeoning, especially with the heightened interest in inclusive growth and the realisation that global economic growth needs to include more people. Coppenolle believes that investments in areas such as renewable energy, or climate transitions can “purposefully trigger positive change.”

Further to this, with increased government interventions and large initiatives specifically looking at climate and how climate targets can be achieved, responsible investment will play a key role in this space.

Data’s role in the education evolution

Amid the coronavirus pandemic, organisations and asset managers alike have evolved their practices to eradicate oversight on ESG related performance indicators in order to better navigate rapidly evolving risks and build long-term resilience.

Coppenolle points out that this will trigger conversations about how ESG risk and impact can and should be measured and reported: the data question.

While there are a multitude of organisations - such as the IFC, GRI, SASB, UNDP or the GIIN - that have already made significant progress and provide guidance and market-agreed standards for impact measurement, management and reporting, the increasing need for commonly accepted and understood principles, such as the IFRS Accounting standards, shows.

“People have been reluctant to invest in ESG-aligned portfolios, specifically into impact investments. Over time, large data providers such as Morningstar, MSCI and Bloomberg were able to collect data on how different portfolio strategies perform and what we have seen now is better performance of ESG portfolios under a Covid-19 scenario.”

Referencing a recent Morningstar report, Coppenolle adds that even though outperformance of sustainable funds during the pandemic might have occured due to divestment from heavily hit sectors, there are increasing studies and datasets that start to evidence that sustainable funds match or exceed the performance of conventional funds over the long run.

Governments, regulators and investors will begin to request information that will allow them to understand how companies address ESG to build resilience and build back better amid continued economic disruption, societal unrest and ever-increasing climate risk.

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