Of all the investor strategies, approaches to environmental, social and governance (ESG) investment have gone through the most rapid evolution in recent times.
“Ten years ago, not investing in things like coal was kind of the de facto approach for institutional investors and the term ESG was used very loosely,” a managing director for a North American pension fund told AsianInvestor.
Over the past year in particular, institutional investors have been placing greater consideration on the environmental impact of the investments in their portfolio construction, he noted.
“In 2021, more investors than ever before have pledged to achieve net-zero emissions by 2050 or sooner which means they are rigorously examining the carbon footprint of not only their own institutions but of their portfolio companies,” he said.
“ESG frameworks are constantly developing and all of that impacts how and where we invest.”
For decades, large institutional investors have been excluding and divesting from socially and environmentally harmful industries to express their ESG conviction, but this way of thinking is fast becoming outdated. To make real positive impact for the future, responsible asset owners are increasingly exerting their scale and influence on these industries.
“We would still never invest in an entity that employs child labour,” he said. “But on the environmental side we might invest in assets that do have higher emitting carbon footprints, but with the aim of bringing that down through our investment.”
”We would never make any investment where we don't have board representation and good governance.”
CURRENT STATE VS FORWARD LOOKING
In 2021, Stanford Business School researchers published an analysis concluding that asset owners divesting from industries that didn’t meet their ESG values had minimal impact on their behaviour.
By selling off their shares, investors give up any influence they may have had over a firm’s corporate policies. As a result, impact investors would be better served by hanging onto dirty stocks rather than dumping them, since with enough shares they could shift corporate behaviour by exercising their rights of control, according to the research.
Michael Kelly the managing director and global head of multi-assets for PineBridge Investments said that the Stanford Researchers work is consistent with his firm’s own experience and reveals two different camps within ESG investing.
“The Eurozone older architecture or ‘current state camp’, who are largely focused on up-front exclusion, and the ‘forward-looking camp’ who recognise that rewarding today's leaders while excluding all others will not always reward those companies or industries where tomorrow's impact is most vital,” said Kelly
“Most independent ESG services score on current state, which can end up speaking only to prior impact, whereas forward-looking impact while tough to validate nonetheless holds the potential for the greatest positive effect which the world certainly needs to find a way to incentivise.”
TAKING ACTIVE OWNERSHIP
Kelly suggests that the "up-front" exclusionary approach of divesting from harmful industries can be credited for jumpstarting responsible investing but believes this has only achieved “very selective and slow” change.
In comparison, asset owner’s taking active ownership of their investments — integrating ESG into buy decisions then, subsequently, as an owner engaging portfolio companies for change — has sped up ESG improvement quite significantly, in his view.
“Management teams respond more to owners than to conscientious objectors,” he said. “We believe divestment should not be the first port of call in ESG if one's goal is to have impact.”
Up-front exclusion can be likened to be the proverbial tree that falls in the forest that nobody hears, said Kelly.
“Active ownership by definition is not to exclude up front, instead it needs to be complemented with effective and persistent engagement, followed by voting against managements when appropriate changes do not ensue over time," he said.
He said that this then needs to be, communicated back to the board as to why one voted against them, followed up by back-end divestment (exclusion) if all else fails.
Long-term institutional investors are fast adopting the preference of engaging first, voting against second, and excluding third when looking to foster real change in environmentally and socially harmful industries, according to Kelly.
“Encouraging the greatest number of companies to improve on measurable ESG metrics is, in our view, better for the world and for portfolios than sending the message to most companies that they are simply too far from the 'investable line' on ESG grounds.”