From the sharp rise in interest in environmental, social and governance (ESG) investing to the unexplored opportunities for investors, this interview gives some insight into how endowments and foundations can approach the sometimes unfamiliar world of responsible and sustainable investing.
Although firms like EdenTree have been focused on responsible and sustainable investing for over 30 years, what do you think has caused the recent sudden interest in ESG from the public, investors and asset managers alike?
As a society, we can be conditioned into short-termism; failing to address serious issues that can’t be solved immediately for fear of missing out on what’s perceived to be results that look good now. The problem is that such an approach can ignore longer-term imbalances, which can be far more impactful, and harder to correct when it starts to go wrong.
More recently, however, we have seen an engaged movement from the next generation that is driving the conversation around the environment forward. It is understandable as these are the people who will live to suffer through the effects that our actions are having on the environment, rather than the policy-makers who are in power now. The attitude these young people have is clear: “This needs to be solved, yesterday”. They’re not simply rebelling for the sake of it. They are seeing proof that the world is being irreversibly damaged; the volatility of the world’s climate, the increasing frequency and strength of natural disasters, the impact a rise in temperature will have on sea levels, and they won’t accept that it is right to continue on in the same way. As responsible and sustainable investors, we see this too. Our research illustrates the persistence and longevity of these issues, and investing in companies that contribute to such problems is irresponsible in terms of the impact they have on wider society and financially likely to deliver lower returns due to the structural challenges.
Overall, the financial community has been and continues to be notably lagging in this area. There are still those who deny the situation out of convenience and see ESG investing as a fashion or fad topic that will dissipate. We think differently, and see a fast-growing opportunity set. We see particular potential in the companies transitioning to more sustainable models of production or, rather than fuelling the world’s problems, are addressing them with practical solutions. In the long term, these are the companies that will not only survive but also thrive.
Do you think it is enough for an endowment or foundation to simply divest from harmful areas such as tobacco or fossil fuels? Or should the approach be more holistic?
Exclusion is one option for investors but it is a fairly basic, commoditised approach. The focus here is on taking things out, and this is where the historic research implied this was detractive from an investment return perspective. However, we see much greater potential in a more proactive approach, which enhances and aligns an endowment or foundation’s mission with the companies it invests in.
We also believe it will be much harder to solve the world’s problems if we all take our own piecemeal approach. Take a charity that is focused on lung cancer that wishes to exclude tobacco only from its portfolio as an example. Given the charity’s mission, it certainly makes sense to do so. But the charity’s mission can be affected by more than one issue. How does air and water pollution by corporations or the behaviour of pharmaceutical companies also affect their mission to eradicate lung cancer? Or a charity focused on issues of social injustice and slave labour that wishes to divest from companies with a poor supply chain. Why not also invest in support of the companies that are seeking to empower and facilitate the communities they work in around the world? These companies will create thousands of jobs and will have more rigorous policies in place as they understand what it takes to thrive in today’s climate.
As a charity, you can align your investment with your mission without sacrificing return. In fact, research is increasingly showing investors can gain superior risk-adjusted returns over the long term through a holistic, responsible and sustainable approach rather than one that just seeks to exclude.
How can foundations ensure asset managers are doing what they’re supposed to be doing? What kind of questions should they ask?
If taking an active approach, endowments and foundations should feel confident that the strategy they’ve discussed with their asset manager aligns with their values and mission. Questions to ask your asset manager include: “What proportion of the portfolio is achieving its targets, where ESG is concerned?”
A headline comment on a return-driving ESG portfolio is no good if only 40 per cent is screened or ethically invested. If an asset manager has started to promote ESG products overnight, then question why, the processes involved and what has changed in the underlying portfolio as a result. Are they merely following a trend or do they have sufficient research in place for stock selection? Try to understand the types of questions your asset manager is asking the companies you invest with. Are they engaging with these companies or analysing them via a third-party data supplier? Given the non-standard nature of ESG disclosure, quantitative scoring is far from a complete picture and good policies don’t necessarily mean good implementation and practice. Your asset manager needs to have a holistic insight to ensure that, further down the line, this seemingly good company isn’t contributing to a wider problem. We believe in active stewardship, voting and engaging with companies we invest in.
Surely the most responsible and sustainable companies are or soon will be priced at a premium to those who are not? What is your advice for endowments and foundations?
There are certainly companies that are already well ahead, and others that are rapidly moving in the right direction. As endowments and foundations and, indeed, other types of investors, adopt responsible and sustainable investing, the underlying companies could experience a degree of valuation re-rating due to their positive contributions and perceived outlook for growth. As more capital is directed towards these strategies, the degree of scarcity will rise, and one needs to be mindful of group think and pockets of excessive valuation. Part of the value an experienced responsible investment manager brings is to identify these companies early on, so that clients can benefit when the market later recognises the opportunity.
Finally, what is your advice for first time ESG investors?
There is a huge level of circulatory here that makes a lot of sense for charity investors. If you invest in the companies with the outcomes your charity itself focuses on, you are contributing to your goal in more ways than one. As first-time investors, don’t be afraid to ask questions and consider the options available. Think about the broader mission of your charity and the ways you would like your investments to reflect that. Certainly, it is right for endowments and foundations to focus on their mission and values; however, there is so much more your assets can do to solve some of society’s biggest problems, and certainly not contribute to them. In the current climate, we need charities and the services they offer more than ever. Adopting an even more holistic approach can ensure your charity’s aims are being fulfilled, not only through grants and projects but also directly through your well-aligned investment portfolio.
David Osfield is a fund manager at EdenTree
Charity Finance wishes to thank EdenTree for its support with this article