Sustainable investing: The road to integration

By Wim Van Hyfte and Fawzy Salarbux, Candriam Investors Group

Sustainable investing is on an irreversible trend from niche to norm. A rapidly evolving regulatory landscape, the landmark 2015 Paris agreement (COP21) on climate change, the mounting body of evidence supporting the financial materiality of sustainable investing, and the increasing focus on ESG by asset owners are but a few key factors supporting the trend.

Headwinds and tailwinds

There are still, however, some lingering misperceptions and challenges impeding the wider incorporation of ESG across a broader spectrum of asset owners.

One key obstacle is the myth that sustainable investing imposes a compromising trade-off with investment performance, therefore conflicting with fiduciary duties. The kernel of truth within the myth stems from the early adoption, almost two decades ago, of exclusionary approaches that had negative implications for diversification and performance. At Candriam, we believe that a thorough assessment of ESG risks and opportunities is crucial to build an accurate picture of our investments. We incorporate factors, often intangible in nature, that are not typically picked up by traditional financial analysis but which have a long-term impact on performance. There is a growing body of research, from academia and the investment community, supporting the theory that ESG investing does mitigate volatility, limit drawdowns and enhance the risk-return profiles of investor portfolios.

There are also some practical challenges such as the lack of time and resources from asset owners. With more investment solutions and improving standards of reporting, these challenges are being more readily met. Although there is some way to go, a dose of pragmatism can help investors establish a starting point.

The lack of high quality information and a uniformity in definitions add to the challenge of investors to formulate an ESG policy. The formation of the Sustainability Accounting Standards Board (SASB) and the recent EU Non-Financial Reporting Directive from 2017, promoting more transparency on ESG disclosure, will help to alleviate this over time.

Despite these challenges, momentum behind ESG investing is building thanks to innovative investment solutions, robust performance of ESG strategies and increased regulatory pressure.

One of the key implications of the 2015 Paris agreement is that significant investment, averaging $1trillion annually until 2050(1), is required to fund the investment gap to achieve a low-carbon and energy efficient economy. This creates significant opportunities for the private sector.

Then there are the demographics. US assets invested along ESG principles, between 2014 and 2016, increased by 33% to $8.7trillion (2). Talk is finally translating into action, especially with ‘Millennials’ more sensitive to the impact of their investments on the society and the environment than their predecessors. Overall, the direction of travel is clear.

ESG integration – which approach works best for you?

At Candriam, we manage over $20bn of assets invested in ESG-related strategies across a broad spectrum of clients and geographies. We observe that each client brings their own beliefs and perceptions to the ESG table. There is no definite, right answer on what is the best approach to ESG integration.

For clients who have significant resources to commit to ESG integration, we see a more rigorous definition and ‘hard-coding’ of investment beliefs at the strategy level. We have been able to assist in the formulation and implementation of their investment beliefs through tailor-made solutions. For a large European asset owner, we tailored a zero-carbon strategy across their equity portfolio to address changing regulatory environment in France.

For clients intent on incorporating ESG but with less resources, we observe that adopting a pragmatic approach, rather than constantly deferring the decision regarding which approach to use, has worked better in terms of creating the framework and the initial momentum to implement ESG. The answer to the question is a pragmatic ‘what works best for you’.