Diversity of Investor Needs, Climate Challenges, and the Over-reliance on Screening

    At a recent Sustainability Seminar in Stockholm, Schroders’s Andrew Howard (pictured right), Head of Sustainability Research, presented his firm’s approach and underlined a few key trends which piqued our interest. According to Howard, ESG has gone from niche to mainstream, and the industry has reached an inflexion point, where accountability and responsibility are now increasingly in investors and customers minds alike.

    In Schroders Global Investor Study 2018, which surveyed 22,000 people who invest from 30 countries around the world, we can find strong evidence that the trend in sustainable investing is positive worldwide. Three-quarters of the respondents said that sustainable investments have become more important to them in the past five years, a proportion that increases to 83% when looking at a younger subset of investors between the ages of 22 and 44. However, Figure 1from the research also underlines investors’ very different views of what sustainable investment means to them, a fragmentation trend that is likely to continue as investors become more informed and engaged with the topic. The diversity in views and definitions is a challenge for asset managers trying to satisfy their customers’ needs.

    Figure 1: Answer to the question “Which of these phrases describes what you think a sustainable investment fund is?”
    Source: Schroders Global Investor Study2018, Respondents may choose more than one answer.

    The tangible effect of climate change on people’s lives around the world is undoubtedly one of the reasons for the increased interest of investors for ESG and sustainable investments in general. At Schroders, significant research efforts have been dedicated to measuring more precisely the effects on the climate that specific activities have. The firm’s ClimateProgress Dashboard aims to track the scale and speed of climate action. The idea behind the dashboard was born from the conflicting opinions the research team encountered about the 2-degree target. “Is a 2-degree scenario possible or not?” was what Howard and his colleagues were asking. “We set about to find out,” he explains. “The two questions we asked ourselves were: ‘How do we get a clear understanding of where we are?’ and ‘What does it mean for companies and investments?’ As a result, we selected a number of indicators, and obtained a set of values for each one of them, using data from reliable sources. For example, we looked at how climate change relates to the number of electric cars on the road. We plotted the number of electric car sales against estimates from the Internal Energy Agency. We calculated that, if we continue on the course we are set on, the temperature rise associated with electric vehicles is 3.3 degrees. Aggregating all indicators, we calculated that we are set to reach a 4-degree increase!”

    On a positive note, it seems that the profitability of alternative energy has increased enough now that we no longer need to rely on a high number of policies or laws to change the industry’s behaviour. Still, the risks and costs associated with a 4-degree increase are phenomenal, and as citizens are affected by the effects of climate change, governments will feel pressure to increase regulations.

    Schroders Sustainable Research team asks the question “What will change?” and analyses the consequences at company, sector and portfolio levels. For instance, one of the most powerful regulatory changes that may eventually take place would be setting the price of carbon atUS$100/ton. As a result, Howard’s team calculates that global cash flows may decrease by 15-20%. From a technological point of view, a 6% p.a. growth in wind capacity may provide a 25-30% market cap positive growth opportunity. In combination with fossil fuel production decrease and physical risk, Schrodersresearch suggests that most portfolios face a 10 to 20% valuation risk under a 2-degree scenario.

    Meanwhile, implementing these concerns or other sustainable investment dimension into portfolios is far from straightforward. Many institutional investors may have found a quick fix in choosing passive mandates that propose ESG screenings and tilts. “The offering of passive ETFs and other such passive sustainable investment solutions have proliferated,” says Howard. Implementing ESG strategies passively may, however, present several pitfalls. Among those, the limited consistency between ratings is a challenge for many sustainable investment specialists and highlights the importance of fundamental analysis.

    Furthermore, many of the so-called ESG or sustainable products are very similar to market products. Some recurring biases may be introduced in ESG strategies due to data availability, and not to sustainability matters. For example, the average MSCI ESG scores increase with market capitalisation. Finally, stewardship without a fundamental knowledge of the companies’ business may be challenging. Corporate engagement and proxy-voting, which are often cited as the ‘active’ tool in sustainable investing available to listed equity investors, may, therefore, be tricky for some passive managers.

    In the end, Howard points out, as the industry matures and clients become more aware, issues like climate change are going to become more and more important. The investment industry is likely to see more innovation in analysis and integration of those factors, moving past traditional ratings, scores and categories. 

    Picture © NordSIP: Senait Asgede (Left), Andrew Howard (Right)

    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA is Editor-in-Chief for NordSIP and Managing Director for Big Green Tree Media. She has 18 years of experience in the asset management industry in Stockholm, London and Geneva, including as a long/short equity hedge fund portfolio manager, and buy-side analyst, but also as CFO and COO in several asset management firms. Aline holds an MBA from Harvard Business School and a License in Economic Sciences from the University of Geneva.

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