Index-linked growth in ESG information

An article I wrote for Sustainable Investments – a special report that appeared in The Times that I also edited.

There is a huge range of tools to help investors choose which aspects of sustainability they want to invest in, writes Mike Scott

Would-be sustainable investors have an embarrassment of riches to choose from when it comes to deciding where to put their money.

In addition to sustainability-focused indices from the mainstream companies such as FTSE (FTSE4Good) and Dow Jones (Dow Jones Sustainability Index), there are also specialist offerings such as the New Energy Index (NEX) and GWI Water Index.

These reflect the two main strands in sustainable investment – companies that are providing specific solutions to environment, social and governance (ESG) issues; and companies that are taking these issues into account in their wider business. In the field of water, an example of the former would be the Israeli provider of drip irrigation equipment Netafim, which helps farmers to use water more efficiently while SABMiller, the global brewing company and therefore a major water user, is a leader in dealing with water issues in its day-to-day operations.

The split also reflects the different types of investor – those that can take more risk and invest in the newer, less proven companies that dominate the clean technology sector and the “universal investors” such as pension funds and insurance companies that have to invest in thousands of stocks and want all of their investments to be in companies that are “best-in-class” and taking into account all possible risks.

The market is evolving towards integrating ESG throughout the investment process and eventually it will simply become part of conventional wisdom, says Thomas Kuh, executive director of ESG indices for MSCI. While “it is far from being a dominant trend at the moment”, a growing number of investors are insisting that their asset managers take these issues into account.

The number of products catering to the market is growing and becoming more detailed all the time. Late last year, for example, NYSE Euronext and Bloomberg New Energy Finance joined forces to launch a whole family of indices. Initially, they created regionally-focused baskets of stocks but this year separate products will also allow investors to track shares in individual sectors including solar, wind, electric vehicles;  and energy-smart technologies such as efficiency, storage and smart grid.

Investing in this area offers a great opportunity, says Mark Hoskin, managing partner of Holden & Partners, because sustainability themes will become more important over time. “We are consuming more than the planet can support and the population is set to rise from 7 billion to 9 billion by 2050.

“Where are the strains going to be felt? It will be in energy, agriculture, forests and water. Past performance will not be a good guide to the future – there is going to be a realignment of valuations. These themes have long-term drivers behind them that should mean above average investment returns over the long term.”

While the returns can be impressive, these markets can also be incredibly volatile. The NEX, for example, which in 2007 rose as much as 57.9 per cent (compared to just 3.5 per cent for the S&P500), fell by 40 per cent last year, even though the sector saw record investment of $260bn in 2011. “The clean energy sector starkly brings out the differences in performance – it is an area where the value of a good fund manager is clear,” Hoskin adds.

There is almost too much information out there for investors, says Katherine Lampen, a senior manager in the sustainability team at Deloitte. But at the same time, there is no clearly-defined and well-agreed common framework for investors. “It is really important that companies and investors focus on the issues that are most material to the business,” she adds. “A lot of indices focus on traditional corporate social responsibility areas such as the environment and community investment – but for the financial services sector, for example, access to finance is a much more important issue.”

An initiative launched last year, the Global Initiative for Sustainability Ratings, aims to cut through the mountains of paperwork. “The proliferation of sustainability ratings providers has spawned inconsistent and often opaque approaches and, in some instances, conflicts of interest among raters and rated companies, plus widespread ‘survey fatigue’ among companies responding to information requests by multiple raters,” says Mindy Lubber, president ofUSsustainable investment coalition Ceres. “With global sustainability crises from climate change to water shortages, resource pressures and population growth more evident every day, it’s time to build a ratings system that distinguishes between those companies that clearly see and act upon sustainability opportunities and risks and those that don’t.”