One good return deserves another ethical investment

Recent events such as the horsemeat  scandal, the collapse of a textile factory in Bangladesh, the US  court case against BP and the revelations about banks  rigging the Libor rate illustrate all too clearly the importance of  environmental, social and governance issues to investors.

And it would appear that investors got the message. Since its launch in 2006,  more than 1,100 institutions representing roughly $32tn of assets under  management have signed up to the UN’s Principles for Responsible  Investment, which encourage investors to incorporate sustainability issues  into their operations.

Great progress has been made, says Neil Brown, a socially responsible  investment analyst at Alliance Trust and chairman of the PRI’s ESG integration  working group. “There is some very good work being done in a volume, quality and  depth that is staggering compared with where we were four to five years  ago.”

There has been a transformation in how asset managers, particularly in  Europe, pay attention to these issues, agrees Vicki Bakhshi, head of investor  engagement at F&C. “There is a greater realisation that poor corporate  governance or a lack of environmental controls can lead to poor performance.  These are issues that are material to the performance of companies in the long  term.”

However, in itself, PRI membership is not enough. “It’s great that so many  people have signed up to the PRI, but in our research, just 9 per cent of  investment strategies are performing really well on integrating ESG issues into  portfolios. It shows that signing up to the PRI does not mean you are  integrating ESG measures. It is just the first step,” says Aled Jones, head of  responsible investment at Mercer, the consultancy.

Many in the industry agree that while things are better than they were, there  is still a long way to go. The main barrier is the attitude and understanding of  asset owners such as pension funds, says Will Oulton, head of responsible  investment at First State Investments. At a recent investment forum held by  First State, 65 per cent of those present said that what would accelerate ESG  integration by asset managers the most was a stronger mandate from asset  owners.

“If you are a large, successful asset manager, why would you change your  business model if there was no pressure to do so?” asks Stuart Kinnersley,  European chief investment officer at Nikko Asset Management and portfolio  manager of the World Bank Green Fund.

“Asset owners have a huge role to play in this, but many pension fund  trustees still believe that ESG means ethical investing, which they believe will  depress returns,” Mr Oulton adds. “But the truth is that mainstreaming ESG is  just sensible investing.”

Philippe Zaouati, deputy chief executive of Natixis Asset Management and  chief executive of the firm’s Mirova socially responsible investing funds, the  second-largest in Europe, says that there is room for both SRI and ESG in  mainstream investing.

“ESG integration is a good thing and it is needed, but to completely erase  SRI would not be positive.”

Natixis, which has €280bn of assets, integrates ESG into all its portfolios  and reports on its ESG engagement to all clients. However, it maintains Mirova  as a separate SRI unit that focuses on eight sustainability investment themes.  “There is a difference between integrating ESG and seeking to create an impact,”  Mr Zaouati says.

To get to the next stage – where integration becomes substantive – “asset  owners that care about this need to start asking some probing questions of asset  managers, such as what resources and expertise they commit to ESG and at what  issues they look”, Ms Bakhshi says.

Answering such questions is becoming easier as the amount and quality of ESG  data improves. It is also due to to initiatives such as the International  Integrated Reporting Committee, which is encouraging companies to incorporate  ESG issues into their annual reports, and the UK’s Stewardship Code, which calls  on investors to consider ESG issues when applying equity mandates.

The trend for increased integration will continue, believes Alliance Trust’s  Mr Brown, because “there is increased demand from the buyside – and they demand  it because they believe it will drive returns. You will see more and more  companies just getting on with it.”

One example of this is the work being done by Axa IM, which uses ESG factors  to help formulate its approach to sovereign debt. It has carried out a more  detailed 18-month pilot project researching the most meaningful ESG issues in  its UK equities portfolio. “The UK equities team now ask specific questions  about ESG,” says Matt Christensen, head of responsible investment at Axa  Investment Managers.

“The answers are collated and used to create a scoring system that ranks  companies. That rank tilts the portfolio towards companies with higher scores  and also identifies the companies the team needs to engage with to get them to  change their behaviour to improve their performance – and therefore our  returns.”

The programme is now being rolled out across the company’s operations in  Europe, Asia and the US over the next two years. “We are seeing more and more  pension funds asking for this information. In five years’ time, things will look  very different. But this is not something that you can change overnight,” says  Mr Christensen.