The practice of environmental, social and governance (ESG) investing may have taken off within the past two to three years, but the concept of investing in companies with sustainable practices has been around for almost five decades.
The term ESG itself was introduced by the late United Nations secretary-general Kofi Annan through a Global Compact initiative in 2004 to encourage the integration of sustainable investing, which led to the publication of the landmark report, Who Cares Wins.
The ESG concept has gone from the initial phase of unfamiliarity among investors to the next phase of scepticism and the latest phase of acceptance when more companies are jumping on the bandwagon. More companies taking on sustainability-linked loans too, with these loans pegged to the companies’ ESG performances.
During the coronavirus pandemic earlier this year, investors were reportedly trying to beat the market by investing in companies that are transparent on their ESG practices, according to a Bloomberg report.
McKenzie says companies with a sustainable business model and strong corporate governance are more likely to withstand volatility in markets, leading to better portfolio resilience, and the potential to outperform
In an interview with The Edge Singapore, Conan McKenzie, co-portfolio manager of the BlackRock Global Funds’ ESG Multi-Asset Fund, says the market is seeing the beginnings of a “persistent and long-lasting shift toward sustainable investing”.
In 1Q2020 alone, about US$40.5 billion ($55.6 billion) in new assets were brought in by global sustainable open-ended funds, including mutual funds and ETFs. This represents a 41% increase y-o-y, according to research conducted by BlackRock in May. “The trend towards ESG strategies has been accelerating and we expect this to continue,” says McKenzie.
“We anticipate many new launches or repositioning of existing funds to ESG to occur over the next twelve months as asset managers seek to align with client requirements. This shift is likely to have an impact on asset prices, which is only just beginning,” he adds.
According to McKenzie, there is a very simple and obvious reason why ESG investing is gaining popularity. “Fundamentally, it’s because investors care about where their money is invested, and people increasingly realise that businesses which operate sustainably and have a positive impact on society are likely to be the ones that produce strong returns for their shareholders over the long term,” he says.
While the concept of ESG is not new, over the last two or three years there has been a noticeable increase in focus on ESG. “Some of this is due to controversies in the corporate world, but people have also become more aware of the impact of climate change and plastic waste and want to reflect their concerns in the way that they invest their money,” he adds.
The ESG difference
What makes an ESG investment different from other forms of investing activities? For a start, it aims to deliver a positive impact on the environment by allocating capital to investments in renewable energy for example, says McKenzie. Secondly, investing in ESG practices can help reduce risks in investments and provide greater resilience in portfolios, he adds.
How so? “The BGF ESG Multi Asset Fund excludes investments in issuers deriving significant revenues from the nine controversial sectors that our research has indicated investors care about the most,” he explains.
“We also focus our investments on those issuers that display best practice from an ESG standpoint and hence will only allocate capital to issuers that have an ESG rating of BBB or above as measured by MSCI,” he adds.
While investors should care about returns, from McKenzie’s perspective, they should look beyond that. In fact, what investors should be looking for, is resilience and sustainability, something companies adhering to stiffer ESG practices can provide.
Companies that do not care about sustainability are more likely to damage the environment, exploit their workers and customers, have bad relationships with their regulators, and generally “cannot withstand the test of time”, he claims.
“We believe companies with a sustainable business model and strong corporate governance are more likely to withstand volatility in markets, leading to better portfolio resilience, and the potential to outperform,” he adds.
The recent market volatility caused by Covid-19 was a chance to put the resilience of ESG investments into test. BlackRock, according to McKenzie, observed better risk-adjusted performance across sustainable products globally with 94% of a globally representative selection of widely analysed sustainable indices outperforming their parent benchmarks. “In a time of maximum market stress, sustainable portfolios proved better able to withstand that stress than unsustainable ones,” he says.
What defines a successful ESG fund?
As a relatively new concept, there are varying ESG standards and frameworks being built and refined. As such, the definition of an ESG fund — which looks beyond merely returns — varies. According to McKenzie, a successful ESG fund is one that offers investors attractive returns, while achieving them through investments that align with their values.
“Increasingly, we find clients take comfort from the fact that they can have a positive impact on the environment and society more broadly through their investments. This was the driving force behind our decision to employ a unique triple-layered approach to ESG when constructing the BGF ESG Multi Asset Fund,” notes McKenzie.
“We wanted to offer clients an approach that had the ability to evolve as market dynamics change and as regulatory frameworks change to take greater account of ESG. The flexibility we have in terms of the asset classes in which we can invest, the broad implementation toolkit in addition to our unique triple-layered approach to ESG really excites me and motivates me to deliver good outcomes for our clients,” he adds.
ESG trends and investors’ appetites
Relative to developed economies where the emphasis on stricter ESG practices have been in place longer, emerging markets generally have some way to go. While there is already growing awareness and also the inclination to adopt ESG practices, the priority for investors in EMs is still the anticipation of monetary returns.
Asia may be the fastest-growing region for investing, with an overwhelming 95% of respondents in Asia Pacific agreeing on the increasing influence of sustainability in investments, but “Asian investors are not ready to invest in sustainable solutions if it means forgoing returns,” says McKenzie. “Sustainability [in Asia] still remains secondary to investment goals.”
The sentiment is similar in Singapore. According to findings from the BlackRock People and Money survey conducted this year, as much as 80% of Singaporean investors acknowledge the importance of their investments being able to make a positive impact. However, the majority (82%) of these investors are only willing to switch to sustainable options should their levels of risk and returns remain unchanged, he adds.
“However, with the recent outperformance of sustainable funds in 1Q2020 and the growing body of research, there is more evidence to support the notion that investing sustainably can provide resilience to portfolios,” says McKenzie.
“As such, we are seeing more Asian investors turning to sustainable investment and solutions in the past few months. Awareness and interest have increased significantly with institutional clients exploring ESG integration approaches, while wealth and distributors turning to best-in-class and thematic solutions.”
Post-Covid-19 reality
Before Covid-19, the fund had generally focused on asset allocation instead of stock selection, as the former has been “particularly important” in delivering good client outcomes, says McKenzie.
However, given the implications of the global pandemic, investors are now increasingly focused on the potential longer-term implications of the pandemic for the global economy, he adds.
“Many businesses which have survived lockdown have emerged with impaired balance sheets and are likely to prioritise deleveraging and building up cash over capex and distributions to shareholders,” he says.
“This has implications for the relative attraction of equities, particularly for investors seeking income. Equally, millions of people around the world have already lost their jobs despite policy action by governments, creating a long-lasting drag on the global economy.”
Looking ahead, McKenzie predicts that the likely after-effects of government interventions has the potential to create an environment more favourable for credit as opposed to equity returns, as investors have to settle for lower earnings in the companies they invest in, as there is a need for them to reduce debt and fulfill conditions imposed by governments in return for support, by cutting or suspending dividends, or reducing share buybacks.
“We believe markets have not yet fully come to terms with the future policy landscape and the implications for asset allocation, which underscores the importance of an agile asset allocation strategy and portfolio diversification in balancing investment risk and return in the coming quarters,” he says.
Given this backdrop, McKenzie believes the BGF ESG Multi-Asset Fund which he co-manages, offers “significant opportunities” in the form of access to bespoke strategies and a “wide range of alternative strategies” that cannot be found in traditional offerings.
“The strength and breadth of capabilities that we can embrace within the portfolio also provide us with significant opportunities for adding value for our clients. Furthermore, BlackRock’s commitment to sustainable investing and the research undertaken in this area means we are in a strong position to lead from the front as we evolve the strategy over time,” he says.
