As the market for environmental and social investing becomes more prominent, investors are rethinking how they assess the non-financial effects of the companies they back — a process set to swell the pool of green assets available.
Funds with responsible investing strategies managed $22.9tn of assets in 2016, up 25 per cent in two years, according to the most recent data available from the Global Sustainable Investment Alliance.
The proliferation of these funds has spurred a multiplicity of investing approaches — from a tick-box mentality to a more nuanced scrutiny of each investment opportunity.
For example, not all wind turbine manufacturers are equal — at least in the eyes of UBS Asset Management. The location in which the turbines are installed can make a material difference in its environmental, social and governance impact methodology.
A company selling wind turbines is a better investment prospect for UBS if the turbines are set up near a polluted city such as Beijing, where they replace carbon-burning energy, than if they are erected in California, where they may replace solar energy — resulting in less of an effect on carbon emissions.
Dinah Koehler, UBS AM executive director for sustainable investment research, said investors’ increasingly sophisticated approach to climate and social impact was driving a push for greater disclosure.
“Traditional ESG measuring has been about how much less bad you are; what we’re now asking is what good you are doing,” she said. “You could have a high-ESG candy bar manufacturer but they would not meet our impact standards.”
As part of its effort to assess companies’ impact on the world in greater detail, UBS has teamed up with Wageningen University in the Netherlands and Harvard University in the US to develop an impact measurement framework that can be applied to companies whose work addresses food security issues.
UBS and Harvard have already developed impact models for climate change, air pollution and health, while UBS worked with the City University of New York on a water-scarcity impact model. These models identify equities that have real-world environmental and social impacts, while still highlighting opportunities in a traditional financial sense.
Investors generally insist their impact methodologies do not justify backing a financially weaker company; instead they are a way of choosing between potential investments that have already met purely financial criteria. The company’s impact rating thus becomes integrated into the overall investment decision.
“We are increasingly seeing private consultancies popping up which create custom methodologies for private clients, while other people are attempting to create public data that financial decision makers can use in their own methodologies,” said Christa Clapp, research director at Norwegian climate studies institute Cicero.
For example, French investment bank Natixis has created a green-weighting factor, an internal capital allocation tool designed to encourage climate-friendly financing. The methodology grades companies on a seven-notch scale: those rated as green see their risk weighting reduced, while groups given brown ratings receive a heavier risk weighting.
The tool has been rolled out to four sectors — real estate, power, automotive and metals and mining — using a combination of external data and information Natixis requests from borrowers. Natixis is now planning to extend it across the rest of its portfolio.
Applying this kind of methodology can significantly increase the volume of green assets available for investors, according to Louis Douady, Natixis’ head of corporate and social responsibility.
“Better defining what green assets are will help us to more effectively label transactions that are green but haven’t been labelled as such and that will help us feed the demand from those investors for more assets,” he said.
As the popularity of impact measurement grows, companies face growing demands from investment houses and fund managers to publish information, provoking a debate about how to standardise these measurements into formal classifications.
UK-based non-profit CDP runs a global disclosure system that is used by 650 investors with $87tn of assets under management to access carbon information on 5,000 companies. Its supply-chain platform is used by 115 multinationals to collect impact data from their suppliers. It has a similar methodology for water use, too.
CDP is not alone. The Workforce Disclosure Initiative sets out a standardised reporting methodology for companies’ employment policies. The Global Reporting Initiative seeks to create corporate and social responsibility standards for companies to use, while the Sustainable Accounting Standards Board lays out key performance indicators for companies to monitor.
These initiatives “have really boosted transparency”, according to Rebecca McLean, socially responsible investment manager at Aberdeen Standard.
“As companies are required [by investors] to report more about these issues, those requirements are becoming more standardised,” she said. “There is a lot of investor support for them, and a push to integrate these kinds of disclosures into mainstream financial reporting in annual reports and so on.”
Paul Simpson, CDP chief executive, argued that impact reporting will become as normal for companies as publishing annual accounts.
“Financial reporting is just a normal part of the healthy functioning of capital markets, and now it is becoming more widely understood that environmental and social information could be too,” he said. “This is becoming mainstream and governments and regulators are increasingly looking into requiring it — that is the way the world is going to go.”
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