ESG still has buzz, but gaps laid bare
Judging by the recent flurry of discussion and focus on environmental, social and governance factors, it’s easy to conclude that an overnight investment management sensation has been created.
That isn’t really the case, however. Responsible investing and its many variants have been around for about three decades and have become more mainstream because investors have either demanded them of themselves because it fits with their philosophies — or they have tasked external managers to implement such strategies.
But progress remains slow and there is still debate over the merits of such an approach compared with the traditional method of basing investment decisions on financial fundamentals.
That theme played out Tuesday, when RBC Global Asset Management released the results of its first global survey. RBC, together with the magazine Pensions & Investments, surveyed institutional asset owners, consultants and clients in Can- ada, Europe and the United States ( 434 responses were received.) Last year, the survey was conducted among North American entities.
In general, the results, presented in Toronto and New York and which were broken down regionally, conform to expectation: Canadian managers lie between the leader, Europe, and the laggard, the U. S. For instance, 45 per cent of European respondents said they use ESG principles “significantly” — almost three times the percentage in Canada and four times the U. S. level. Overall two- thirds of respondents said they use ESG principles as “part of their investment approach and decision-making.”
The question is the extent to which ESG scores may alter an investment decision based on fundamentals. It seems managers are concerned about how such a switch decision would affect performance.
Indeed t he sur vey revealed the first question asked of investment consultants, the companies that act for pension funds when managers are hired and replaced, was “will returns suffer” by making such a switch. That question is asked even though about 80 per cent of respondents in RBC’s survey believe integrating ESG factors will mean performance equal to or greater than performance without such integration.
That expectation is what the UN’s Principles of Responsible Investing found when it looked at more than 2000 studies from 1970 — 2015. In 90 per cent of the studies, performance was either neutral or positive.
About half that percentage consider ESG as a risk mitigator, an average that masks a regional gap: from 77 per cent in Europe, to 68 per cent in Canada and just over 20 per cent in the U. S. As a source of alpha, or outperformance, ESG is looked upon favourably by the Europeans ( 51 per cent) but less favourably in Canada (37 per cent) and the U. S. ( below 20 per cent.)
John Cook, president of GreenChip Financial, a firm formed in 2007, attended Tuesday’s session. That firm, which has one fund, was formed on the thesis that demographic changes, resource scarcity and environmental degradation “would create a resource efficiency revolution.” The global environmental- themed fund, which has boasted stellar performance over many years, owns one Canadian security, Boralex.
Cook said “generally it’s too easy” for managers to say they are integrating ESG in the decision-making process “but have a tough time explaining how it leads to different security selection and asset allocation.”
One way, Cook posited, would be for investors, when undertaking financial modelling, to apply a lower discount rate to issuers with a high ESG score and a higher discount rate when the ESG score is low.
“The way to track ( the influence of ESG) is to determine whether it affects the value being ascribed to a company,” he said. “In my view too many managers who say they use ESG use the term too lightly.”