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From niche to mainstream: how ESG is transforming investment

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FundForum International 2019 in Copenhagen kicked off with a special summit day. With focused discussion tracks on ETFs and ESG, Formative's Senior Writer, Alex Thornton reports live from the conference on the transformative nature of ESG.

Environmental, social and governance (ESG) investing is a fashionable topic. But it is no flash in the pan. What was once dismissed as a niche - a small range of products of dubious profitability aimed at a particular range of clients - is now mainstream. The UN Principles for Responsible Investment (PRI) are now driving decisions at all levels: from an analyst’s evaluations of individual investment opportunities to boardroom strategies for entire companies.

But there are still significant questions about ESG. Can it even be defined and measured? How does it balance with the fiduciary duty to maximise investment returns? Who decides whether an investment meets ESG goals, and how? And can a precaution against doing harm be translated into a positive force for good?

These issues were at the heart of discussions at the FundForum International summit on ESG held in Copenhagen on Monday 24th June 2019. As speakers from all sides of the industry - investors, asset managers, funds and NGOs - put made their cases, several common themes emerged.

The problem of definition

If there is one problem that those involved in ESG consistently come across, it is the question of definition. There are clear examples of what definitely aligns with ESG goals (for example, clean energy), and what definitely runs counter to ESG principles (tobacco and the arms trade were widely cited). But there is a lot of grey area in between; where decisions over whether a particular investment fits within a particular philosophy are highly subjective.

"It was significant that several of the panels a the summit had a majority of women, and it was noted by several speakers that ESG is regarded as a way to increase female participation in traditionally male dominated asset management."

The European Union’s project for a common taxonomy was broadly welcomed by summit attendees as giving a much needed framework that can be used by all parties. Susanne Bolin Gartner, Head of Fund Selection, Unit Linked Insurance at Swedish insurance company Folksam was one of several who pointed to the benefits of standards everyone could agree on during a panel on the best practice of fund selection and ongoing monitoring of external managers. However, like many, she saw it as a lowest common denominator to be built on - a start, rather than an end.

Assessing and evaluating

Even with agreed definitions, assessing individual investments, funds, and even fund managers is tricky. The quantity and quality of data is improving dramatically, and there are external providers who do score funds and fund managers for ESG. But there was a caution against using these ratings as the whole and only truth. There is always an element of subjectivity, and a need for constant re-evaluation.

Several delegates argued that there was no substitute for asset managers who genuinely believed in the principles of ESG rather than seeing it as a box-ticking exercise. Investors want asset managers they can trust with their reputations. Janet Muir, Director of Finance at the Crop Trust, pointed out how important this was for investors like her organisation, which was set up the UN to ensure food security and crop diversity. With the overwhelming majority of its funds coming from governments, there could be no question of any controversy. Instead, she relied on trusted asset managers with experience in ESG who took an active interest in ensuring investments were properly aligned.

The need for transparency and disclosure

This trust is most easily built with asset managers who are comfortable explaining their methodology and reasons for making particular decisions.

This transparency is particularly important given the likelihood that different clients will have different understandings of what fits their ESG philosophy. The clear message is: it doesn’t matter if there isn’t complete alignment, as long as there is full disclosure. If a client is given all the relevant information about their investments, they can decide for themselves whether they are happy with it.

From talking the talk, to walking the walk

Increasingly ESG investors are demanding an integrated approach that permeates every facet of the financial institutions they deal with. This means applying ESG not just to individual products that are packaged up and sold as being “ethical”, but to all investment decisions that the institution makes.

Demands is particularly being driven by younger investors. Millennials are much more likely to insist that their money is being invested in particular ways. ESG is also seen as a way of attracting a wider variety of talent to the industry itself.

It was significant that several of the panels a the summit had a majority of women, and it was noted by several speakers that ESG is regarded as a way to increase female participation in traditionally male dominated asset management.

ESG to SDG and beyond

ESG began with a precautionary principle of “do no harm”. Certain investments were excluded and screened out, and all others considered fair game. Now there are signs of a shift towards a more active desire for investments to have a positive effect. Sustainable development goals (SDGs) are increasingly taken into consideration, although that brings further complications in how the effects can be benchmarked and measured.

The trend includes a greater appetite for impact investing, where the investments can be directly linked to tangible social and environmental benefits. Both sustainable and impact investing are strongly associated in popular imagination with climate change and environmental concerns - the E in ESG.

"...The use of data in the cities we live in will be a highly productive outlet for ESG investment in the generation to come, benefiting citizen and investor alike."

There was a broad acceptance that the so-called Greta Thunberg effect was focussing minds on the urgency of protecting the environment, but several expressed hope that other sectors, such as education and healthcare, wouldn’t be ignored.

The future: Smart Cities and data

A fascinating case study that incorporated many of these themes is the case of smart cities, a natural choice for a summit held in Copenhagen. The city is one of the leading examples of how investment in ESG can actually make a practical difference to quality of life, while reducing the damage done to the environment. New technologies are being harnessed to provide solutions to long-term problems, with the potential to be highly attractive and profitable investments.

Rasmus Reeh, Senior Adviser at Copenhagen Solutions Lab, pointed to the transformative power of directing capital into projects with strong social benefits, particularly as part of the digital revolution. Cities provide a large amount of data, that can be useful to private companies, and vice versa.

However, as Martin Brynskov, Chair of the Danish Standard Committee on Smart Cities and Communities at Open & Agile Smart Cities, argued, these benefits can only be scaled up globally if there is trust. The key to trust is, as already seen, transparency and disclosure - people want to know what they are getting into.

Investors and cities alike also need a common framework for negotiating the balance between privacy and profit. With 500,000 different local governments in the world, it would be impossible to provide stable returns to investors without a common approach that all agree on.

But is these issues can be worked out, the use of data in the cities we live in will be a highly productive outlet for ESG investment in the generation to come, benefiting citizen and investor alike.

FundForum International 2019 runs from 24 June - 27 June 2019 in Copenhagen. Find out more here.

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