By Robert De Guigné, head of socially responsible investments and ESG solutions, Lombard Odier Investment Managers
What happens when you enhance the focus of your ESG analysis with genuine environmental and social impact criteria? You realise the full potential of ESG, and create the “100%-Impact Investor”
From Ethics to Impact: A Long History of Innovation
At the beginning of the 2000s, some investors decided that they wanted to finance companies that did not merely behave responsibly and sustainably, but also worked on solutions to the world’s most pressing challenges. They wanted their capital to be put to work for direct social and environmental impact. They developed the first microfinance funds and impact venture capital strategies. They designed the first Green Bonds. The era of Impact Investing had arrived.
“Going deeper” with impact analysis often takes investors to places where mainstream investors cannot follow: it is easier to monitor the real-world impact of capital allocated to a portfolio of small, private companies, or Green Bonds, than monitor it in the buying and selling of a diversified portfolio of listed stocks. “Getting broader”, on the other hand, requires us to integrate impact criteria in ways that do not affect the asset allocation, risk-return profile or liquidity target of our investment strategies.
However difficult, we believe investor demand will make this unstoppable. A generational shift will see trillions of dollars transferred from baby-boomers to millennials over the coming decade: they think one of the top priorities for any business should be “to improve society.” It’s clear to us at Lombard Odier IM that “Getting broader” and “Going deeper” ultimately means the complete integration of impact analysis into mainstream investing, and the creation of the “100%-Impact Investor”.
Towards 100%-Impact Portfolios
Even without this generational shift, we see two powerful forces pressing impact into its rightful place alongside responsibility and sustainability. One is regulatory: national and international rules and guidelines for investors increasingly recognise impact criteria.
The second is that investors can already point to 30 years of evidence that ESG analysis helps identify some of the key characteristics for sustainable financial returns. It is reasonable to assume that enhancing that analysis with a greater focus on impact might improve performance still further.
Our own analysis supports this assumption. Like many impact-conscious asset managers, Lombard Odier IM monitors a “Controversy Radar”: we looked at the blips on this radar alongside the returns of the 5,000 companies in our database over seven years, and found that whenever a stock jumped from a low category up to the most severe category-four or five controversies, it lost an average of 4.5% in one month (the two weeks before and after its peak controversy rating).
Moreover, over the past three years that average loss has jumped to 12.5%*. Simply excluding the bottom quintile of companies based on our ESG ratings halved the probability of a portfolio experiencing a peak in the Controversy Radar. Controversies arise from visible social or environmental impacts, so these results show that companies’ ESG scores do correlate to some extent with their real-world impact. But there are plenty of exceptions to make us question whether the full picture is captured by conventional ESG analysis, which assesses companies’ organisation and direct operations but doesn’t say much about their products.
Think of Total, for example. It scores well in most ESG models, despite the fact that its core product is a leading contributor to greenhouse gas emissions. At the same time Tesla, which has not yet formalised its code of ethics or implemented state-of-the-art governance, gets a fairly poor ESG rating despite helping to revolutionise clean transportation.
It is partly to catch such anomalies that we at Lombard Odier IM have introduced a proprietary carbon intensity tracker for our universe of stocks. But we have also enhanced our ESG approach itself with an additional analytical framework, “CAR” (“Consciousness, Actions, Results”), which looks beyond companies’ stated intentions on responsibility and sustainability and into the actions they have taken to get measurable results.
We go further, scoring for “Action” when a company sets up awareness and talent-development programmes for female staff for example, and “Results” if it can demonstrate a consequent increase in women in senior management. This helps identify good ESG practice that is having real-world impact, as opposed to good ESG practice designed to “greenwash” corporate social responsibility reports.
*Source: LOIM as at 31 May 2017.
IMPORTANT INFORMATION: FOR PROFESSIONAL INVESTOR USE ONLY. This material does not constitute an offer or solicitation in any jurisdiction where or to any person to whom it would be unauthorised or unlawful to do so.
Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice. No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a financial promotion and has been approved by Lombard Odier Asset Management (Europe) Limited which is authorised and regulated by the Financial Conduct Authority. Past performance does not guarantee future results ©2017 LOIM. All rights reserved.
