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ESG and economic uncertainty

09 Mar 2023 Expert insight

Investec’s 2022 charities conference considered how the new era of economic uncertainty might change the emphasis within ESG investing. Ian Allsop reports.

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Investec’s September 2022 charities conference brought together experts and charity representatives to discuss environmental, social and governance (ESG) and responsible investment in an age of uncertainty. Investec’s head of charities, Nicola Toyer, states that in an increasingly challenging economic environment, it is more important than ever to come together and address these issues.

“We have seen an immense amount of changes, both as charities and individuals. The war in Ukraine has disrupted global supply chains for energy, which has changed the conversation on climate change. While COP26 bought the race to net-zero to the top of the agenda for many investors, we are now facing up to an over-reliance on Russian energy and the conversation has moved more to the need for energy self-sufficiency. Many charity trustees are seeking to maximise investment returns in a way that is responsible and meets their charitable goals. But how can you navigate the current problems while remaining responsible? There is no one solution to the challenges ahead, but collaboration and communication are key.”

Alison Taylor, CEO of CAF Bank and CAF Charity Services, sets the context. In early 2022, Charities Aid Foundation (CAF) undertook some research with the Institute of Chartered Accountants in England and Wales (ICAEW) assessing the main things charities were focusing on coming out of the pandemic. “It was a point of reset and a chance to look forward with positivity. Respondents were concerned about financial resilience, digital fundraising, diversity, and sustainability and the climate change agenda. But now, against an arguably more challenging backdrop than Covid, these issues still remain, and it is important that the immediate pressure on finances doesn’t detract from the sustainability agenda, climate change, and responsible investment goals.”

She describes the situation as a “perfect storm” for the sector. “We have rising demand pressures, falling donations and income, rising costs, with many charities still in a depleted reserves position. And the full effects are not with us yet, which is the most concerning aspect. We are waiting for it all to crystallise. Charities are often the first line of defence in times of austerity. Social care, mental health, food banks are the obvious ones. But then financial advice, homelessness, animal welfare, and domestic abuse, for example, will all be affected by the demand dynamic.”

She mentions shrinking numbers of donors in the UK. “Donors are giving more but there is a reliance on a smaller group of people. CAF’s monthly UK Giving report in February found that 12% expected to cut back donations over the following six months. This has risen to 22% as people face their own financial pressures.”

More of the S in ESG?

In light of this challenging economic backdrop, what should investors focus on? Is it time to review ESG investing and the S factor, and turn up the volume on social issues?

Max Richardson, senior investment director at Investec, suggests that the S is often superseded by the E in ESG but it is critical to ensuring a just transition and solving inequality. “Even if you view the world through a narrow financial lens, equality and trust in society is critical to market integrity. The entire global system is predicated by trust in institutions and each other, particularly at the minute. When trust breaks down, politics moves to extremes and hampers our ability to meet ESG goals.”

He makes a distinction between uncertainty and risk. “Situations that involve risk tend to have a finite number of outcomes and are relatively easy to predict. Uncertainty invariably has an infinite number of outcomes and the shocks are harder to model. But we will need to get used to uncertainty.”

ESG and sustainability

ESG is often used interchangeably with other terms such as sustainability. What does it mean and why is it important? Anna Shiel is chief investment officer at Big Society Capital, which she describes as an impact investor, meaning that it seeks “to have a positive impact on outcomes in society”.

“How does that sit with ESG? Firstly, along the spectrum of capital, ranging from avoiding harm to solutions for societal problems, we are towards the latter whereas ESG is nearer the former.”

Shiel adds that ESG is about how you make investments, by identifying risks. “Social impact investing is around the ‘what’ – what themes and issues do we seek to make a positive difference around? The ‘how’ is important but we are also focused on what change we can make.”

Bettina Reinboth is director of human rights and social issues at PRI. There have been over 5,000 signatories since 2006 to the UN’s principles for responsible investment. “ESG, for us, is about incorporating and integrating those factors into any decision-making around these six key principles. We focused on S as much as E and G from the beginning but it was more reactive and ad hoc. Now we are trying to be more systematic about those issues and to elevate them much more. In terms of how the ESG space has changed, for investors it is about thinking about negative and positive outcomes from their investments, and focusing on the positive ones. Today’s world is different from 2006.”

“ESG is what we do. It is not even advanced. It is just basic,” states Danyal Sattar, CEO of Big Issue Invest. “Of course, you want good governance, but the social is vital. We are in society. It is an interesting economic time. In 2008, society stood behind the banks as taxpayers. None of us are detached. The obvious definition of ESG is if you are doing good or aren’t. It is obvious. Yes, you need data and metrics but sometimes instinct is a good indicator of ESG as well.”

Charity sector leadership

So, in terms of fiduciary duty, what is the role of charity leadership in relation to ESG risk? Sattar thinks it needs to be at the forefront of these matters. “In the charity sector, we are the core of what is good in UK society, so it absolutely needs to be reflected in our own portfolios. It is a good thing I am not in charge of the Charity Commission as I would be mildly stroppy with some of the foundations. Do you think you are investing in accordance with your charitable mission? Are you maximising your resources? What if you applied 100% of your assets for impact and bring the full weight of the endowment to bear rather than aiming for spending just 4%? There is a pattern of investing and giving away a small bit of it, rather than saying our aim should be to directly invest in line with our mission. We can do more of this as a sector.”

Reinboth echoes that sentiment. “In terms of fiduciary duty, ESG is very much part of it. Within that, what does the S mean? It is much clearer on the E side. We need to showcase leadership in these areas, so it trickles down the investment chain. The charity sector has the passion and mission, and knowledge of what is happening on the ground, so there are benefits from seeing the issues and putting them on the agenda for asset owners. We definitely need to have leadership pushing this so everyone in the financial ecosystem can draw on it and identify what needs changing.”

Shiel refers to leadership and knowledge. “When it was formed, Big Society Capital was the new kid on the block. We were set up with a goal to create positive impact. Where are the areas where you can invest to create social change? This came from conversations with charity leaders. Where were their needs, and the needs of beneficiaries? Without that guidance and expertise from charities we would not have known where to start.”

Measuring impact

So how should charities measure impact for donors and beneficiaries? Is it about additionality? Shiel suggests that it depends what we mean by impact. “It is change that happens, that wouldn’t have happened otherwise. It is hard to have that without additionality. You can’t separate impact from it, and we need a new way of talking about it. That’s why intention matters. Unless there is an upfront definition and understanding of the change we seek, how we measure progress is slightly meaningless.”

She is sceptical about impact reporting that attributes value to every social consequence. “Of course, any investment has a social impact. But the question is, what was the intended impact and how do we understand progress – and sometimes, why it didn’t work. You need to think about who the target beneficiaries are. Who was it intended to help? Have we reached them? If not, why not? What change occurred? What unintended consequences were there? How can we do it better?”

Sattar likens impact measurement to flying a plane at night. “During the day, it is easy. You can see where you are going. And impact is really obvious if you can see change. But you can’t fly an aeroplane at night by the seat of your pants. You need a few instruments to help you see what you are doing. Impact investing can be simple and obvious but you need to check reality sometimes with simple measures.”

Toyer concludes by saying that responsible investment and ESG is “more important than ever as we address macroeconomic challenges in our society. And nothing is more rewarding than knowing that investments managed on behalf of charities are supporting beneficiaries.”

Ian Allsop is editor of the Charity Finance Yearbook and contributing editor to Charity Finance

Charity Finance wishes to thank Investec for its support with this article 

The Charity Finance Yearbook is the ultimate reference source for charity finance professionals. Produced by the Charity Finance editorial and research team it includes updates, advice and trends on accounting and audit, VAT and taxation, investment strategy, responsible investment and finance, risk, funding, performance and governance, law and regulation, HR and pensions, IT and property. Purchase online here.

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