Heard At Responsible Investor Europe

European institutions are often considered to be leaders in responsible investing. Castle Hall was pleased to attend Responsible Investor’s recent conference in London to find out how European asset allocators and asset managers currently view sustainability-focused investing.

• The European Union’s Action Plan on Sustainable Finance was a key theme of the conference. The legislative proposal for the creation of a taxonomy for environmentally sustainable activities was discussed at length. Overall, conference speakers suggested that – while the EU initiative is a positive step in providing a regulatory framework for responsible investing - it does have some limitations. A panelist accurately pointed out that the analysis of environmentally sustainable activities overlooks social and governance issues within an issuer. For example, the taxonomy fails to address how issuers are tackling the Just Transition in worker retraining and early retirement. Furthermore, the scope of taxonomy alignment assessments may not fully consider product lifecycle and supply chain analysis – an electric vehicle battery maker may, for example, have exposure to human rights violations in the sourcing of cobalt, a rare metal sourced in conflict zones. A different speaker highlighted the problem surrounding the creation of an EU-label for funds based solely on the taxonomy (in other words, “check the box” based on EU criteria). There is at least some risk that asset owners may simplistically buy into labeled funds, without actually assessing how the manager’s strategy is executed and whether there is truly meaningful ESG integration.
• Gathering information and purchasing research from ESG data providers is a good start to implementing sustainability into investment decision making. However, not all data is created equal. One manager speaking at the conference highlighted that different biases exist between service providers, making the comparison of strategies challenging when comparing data sourced from different ESG data vendors. Further, other panelists highlighted independence issues: Credit Rating Agencies that now provide ESG-related data get paid by the companies they rate, creating substantial conflicts of interest. Managers and their research teams must be cognizant of these issues to improve their investment decision making process.
• Climate Change is looming and presents a systemic risk for all portfolios. Managing carbon-related risk requires both carbon accounting and scenario analysis. Attendees discussed the potential for data on carbon emissions to be misleading: for example, when looking at the carbon intensity (t CO2e / $ revenue) of utility companies, some may look “dirtier” than others if they operate in regions where energy prices are lower. More broadly, best practices regarding stress testing and scenario analysis have yet to be established. As one example, transition pathway scenarios have been heavily criticized due to the lack of independence of the bodies creating them. A speaker highlighted that the IEA’s scenarios rely too much on Carbon Capture and Sequestration, a technology which has not been proven to be cost-effective and scalable to date – but is still included in some scenario analysis. It is, therefore, essential for investors to stress test their portfolios to better understand the biases embedded in transition pathway scenarios.
• During the ESG in manager selection session, European-based asset owners highlighted the trends in the industry. Though most managers are keen to integrate ESG analysis into their portfolios, they are progressing at different speeds. Some have ambition but don’t have sufficient resources to effectively analyze data; others have fully integrated ESG issues into their resources, ambition, investment teams and value proposition. An asset allocator highlighted the importance of comparing a manager’s ESG mandate with their other mandates, as it allows to get a better understanding of whether the ESG strategy has been created to gather assets - or if it’s inherent to the overarching strategy of the manager. One asset owner panelist went further, describing a methodology which seeks to assess how sustainability is embedded in the DNA of an asset manager. Can that asset manager demonstrate internal adherence to ESG principles, to be evidenced by the diversity of its employees (cognitive, ethnic and gender-related) and the implementation of inclusion policies? In other words, do asset manager talk the talk…but also walk the walk?
• As investors seek to replace existing strategies for solutions that deliver more than financial returns, they have been allocating more assets to impact funds. Most Impact strategies focus on private markets and themed securities - indeed, thematic securities such as green and social impact bonds are generally issued by companies in similar sectors and industries. Consequently, investors must be aware of heightened concentration risk. Furthermore, issues surrounding impact measurement have made it difficult to get “under the skin” of these investments. Measurements are not perfect, and investors must do their homework on what different managers are reporting. Each impact project must consider the context in which it is being undertaken. In the case of a fund invested in health care, simply measuring the number of hospitals built is not enough. A manager must go deeper and assess the location and the communities being served by the project to gain a better understanding of the overall impact of the investment.

Overall, our view was one of an industry in transition: ESG is moving beyond the virtue signalling of “a simple answer to a complex question”, with investors increasingly focused on greenwashing, and whether asset managers actually deliver impactful ESG value within their portfolios. And, in addition to ESG portfolio construction, investors seek to understand whether the manager themselves – the vendor of asset management services – is themselves focused on E, S or G best practice.

We thank the organizers and the sponsors for an insightful and successful event!