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ESG - Investment for a brighter future

Climate change and pollution, people working and living under repressive conditions, with mismanagement and corruption adding fuel to the fire. These are the challenges that impede human development and progress. Investors and asset managers are done with being idle bystanders or even inadvertently making things worse.

April 9, 2021

ESG (environmental, social, and governance) investing is done playing a niche role. Promising a constructive approach to the problems besetting the planet while at the same time offering better risk/return characteristics than traditional strategies, ESG is a new paradigm in asset management. As such, it should be seen less as a trend than as a path to the new normal. Already widely adopted by many institutional investors, it is currently continuing its expansion into the portfolios of private and additional institutional investors. In fact, portfolio managers and investors are actively pushing to introduce ESG into more and more segments and markets – recognizing both their own responsibilities vis-à-vis the greater good, and hoping to reap the benefits of the approach on a broader front. In this environment, Credit Suisse Asset Management has formulated ambitious goals of not only managing practically all investment funds according to strict ESG criteria, but also of nudging peers and investee companies onto more sustainable paths.

A way forward with strong drivers

The two aspects of ESG investing – collective responsibility and enhanced risk/return – are not totally independent. A society that values sustainability will tend to reward companies that act accordingly. Such companies will be able to avoid the reputational risks that come with being a polluter or treating various stakeholders poorly. But the effects go deeper, and companies with more diverse, better treated workforces, or rigorous environmental policies – both of which would enhance an ESG score – will also have sounder business models, more sustainable earnings, and be better suited for the challenges of the future. In this way, a high ESG rating becomes a factor for any portfolio manager in determining the potential of an investment.

This foundation, consisting of the determination to preserve a livable planet for future generations while engaging in a prudent and profitable investment strategy, has transformed sustainable investing into a generational and paradigm-shifting phenomenon. In many ways, it remains in its early stages, marked by a kind of pioneering atmosphere that is heady and dynamic on the one hand, yet can be confusing and overwhelming on the other. An example of the latter is a dearth of standards and labels that would enhance transparency and make decisions easier for all participants, individual investors as well as companies. Many regulators have not yet defined what they consider to be a sustainable or ESG-conforming investment, let alone that such definitions would be aggregated up to a regional or even global level. But some standards, or at least guidelines, exist. Most prominent among these are the Principles for Responsible Investment (PRI), formulated by the United Nations in 2005.

Steps in the right direction

Generally, it is important to have a clearly defined framework for proxy voting and engagement principles and activities to act in the best interest of clients. In addition, we also exercise our voting rights at globally active, large multinational companies. Looking to 2021, we will be further extending our coverage to Asia-Pacific as well as North America. As of today, for Swiss companies we have a coverage ratio of almost 100% for SMI shares and roughly 50% for SPI shares.

In terms of engagement we have also ramped up our activities:

We work together with companies to set clearly defined KPIs for quantitative goals that are tracked and monitored over time. For qualitative issues, we use our proprietary questionnaire to evaluate the progress a company is making. All engagement activities are normally undertaken via one-on-one meetings or conference calls in which we mostly meet with the chairperson and/or BoD members, or in some cases with investor relations.

As an asset manager, it is desirable to join collaborative engagement initiatives such as Climate Action 100+, which is devoted to net-zero emissions in investing and represents USD 47 tn in assets. Membership in this and similar initiatives represents an opportunity to leverage and enhance influence. Readers are encouraged to find out more about this important initiative on the website. It is always fashionable, to a certain degree, to decry the influence of money in society. This is an example of making it a force for good.

The “Principles for Responsible Investment”

In the last 15 years, over 3,000 professional asset managers, including Credit Suisse, representing over USD 100 tn in assets have committed themselves to the PRI. In other words, the PRI have become the closest thing to a global standard for sustainable investing in existence, and this makes them worth quoting in full:

Principle 1
We will incorporate ESG issues into investment analysis and decision-making processes.

Principle 2
We will be active owners and incorporate ESG issues into our ownership policies and practices.

Principle 3
We will seek appropriate disclosure on ESG issues by the entities in which we invest.

Principle 4
We will promote acceptance and implementation of the Principles within the investment industry.

Principle 5
We will work together to enhance our effectiveness in implementing the Principles.

Principle 6
We will each report on our activities and progress towards implementing the Principles.

While they are mostly self-explanatory, some important aspects are worth pointing out. The principles acknowledge that making the financial world is a work in progress, and that cooperation, active engagement, and transparency are essential to success. The principles are also expressed at a very high level, leaving much of the concrete implementation to individual investors.

Sustainable portfolios

In the end, and most importantly, the increasing inclusion of ESG in decision-making processes affects the portfolios of funds and mandates. This effect varies by asset class, sector, and region. In some segments, data quality is a big issue, and understanding actual sustainability risks and opportunities in combination with traditional financial analysis is the right way to go. Therefore, it is important to work with specialized data providers while retaining the ability to cross-check and test the plausibility of both data and results. In line with a consistent and comprehensive ESG framework in which some segments are entirely excluded from sustainable portfolios. On the active ownership side, companies are influenced to take a more sustainable direction and transparency is writ large, e.g. via dedicated ESG reporting.

The most profound effect has been seen in the emerging market space. These markets have lower levels of transparency and are institutionally less stable than their more developed counterparts. Under these conditions, the inclusion of ESG criteria in investment decisions is an invaluable tool to determine the quality of a company’s leadership, its risk structure, and the solidity of its business model. While the phenomenon of ESG improving the quality of a portfolio is significant almost across the board, it is most visible in the emerging markets, which can be seen in the performance of sustainable emerging market equity indices compared to their traditional parent indices.

At this point, the question is no longer: Can I afford to invest sustainably? It is: Can I afford not to? And the answer is no. Both because of the environmental, social, and governance problems facing global society, and because investors want a solid return on investment.

 

New in Scope: If not now, when?

Irrespective of the pandemic, however, the spectrum of investment opportunities has actually widened further. "If not now, then when?" expresses an increased willingness to rethink matters at a fundamental level. The new opportunities and challenges this creates are explored in this issue of Scope.

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