“Data from external parties are insufficiently transparent to be able to rely fully on in ESG investments. Moreover, the scores of these parties are often based on information and performance from the past. Particularly in the case of sustainability, a tool must help investors look ahead.”
This is what Hannah Simons of Schroders Investment Management said in an interview with Fondsnieuws, Investment Officer’s Dutch-language sister publication. An in-house ESG tool is therefore essential for investors to really understand the impact of sustainability through its risks and opportunities. “If an external party gives a certain investment a plus or a minus or an A or B, but we don’t know the input for that rating, we don’t really know how to react to such advice.”
Simons, who sets Schroders’ sustainable strategy, made the statements in response to a question about why Schroders built the comprehensive analysis tool Sustainex, alongside everything else that is already in place. The tool measures the costs that companies and society would face if all their negative externalities were priced, or the incentive if the benefits were recognised financially.
“If you build an instrument yourself, you can control all the elements,” said Simons. “This is so important if you want to fully understand your own investments. Data from external parties are often based on reported figures. Of course, we also use historical data, but we mainly look ahead. For example, we measure the consequences of a rising carbon price for companies, instead of looking at their current carbon footprint.”
Sustainability in RFPs
Schroders’ framework aims to give analysts and fund managers an overview of the many different facets that can influence the sustainability of an investable company. Information they can then implement in valuations and investments.
Such a proprietary tool is expensive, Simons agreed. At the same time, she said she sees it as a justifiable investment, since the adoption of sustainability by clients has accelerated again this year. “In 90 percent of the RFPs, clients ask us questions about sustainability, regardless of the underlying mandate. Just a few years ago, that was about 50 percent. In addition, their questions are now very detailed, which shows how much attention they are paying to the subject.”
She does not agree with the idea that clients are tired of the bulk of emails and information documents from asset managers about ESG. “They want to know more about our ESG principles. The meeting we organised on the implementation of the European SFDR regulation was attended by over a hundred clients. That is a lot. People are so eager to learn. It is a complex, multifaceted investment theme, full of jargon. What does SRI mean, what does responsible mean, what does impact mean? To navigate through all that, clients seek interaction with asset managers.”
Impact alongside risk and return
As far as Simons is concerned, the investment industry could well go a step further, by starting to see impact as the third leg of an investment decision, alongside the fixed pillars of risk and return. “We are in a new paradigm. A paradigm that asks us to look beyond risk and return.”
As environmental awareness and concerns grow, flows towards sustainable funds are steadily increasing, she argues. “Last year, during the outbreak of the Covid pandemic, we already saw a clear increase in flows. In 2021 we will see a similar trend. The desire to help build a sustainable future is clearly there. If we are to meet the better future that the UN can bring about with its SDGs, we will need to bring significant wealth to the industries that can lead the transition.”
According to Simons, the relationship between that determination and investment decisions is best explained through clients’ long-term goals. “If we don’t take the opportunity to make an impact, we won’t achieve those returns. Long-term trends influence future returns. For example, with the climate goals of governments and companies, we will see a reduction in carbon emissions. That will create winners and losers. And it will happen, whether clients want to invest in it or not. We have to take those opportunities to get returns in the long term.”
End of the beginning
According to Simons, clients understand that in order to go along with this, they have to let go of the old risk-return model. “They certainly want to consider what that would look like. They want to learn about the tools we have developed, how it affects our investments, how it is woven through our investment process. Impact is not a substitute for risk or return. It goes together with those two elements. You add a third dimension.”
Philanthropy is really something else here than adding sustainability to your investments, she emphasises. “There are clients who are willing to sacrifice return for impact, but these are charities and foundations with a specific charitable purpose. In the mainstream, clients want a method where they can combine it, rather than seeing it separately.”
Asked about the next phase in the theme, Simons says that the SFDR regulations have ushered in a new era. “As a result, we are now in a different environment. That does not mean we are finished. Market standards change continuously, cause a journey. This is the end of the beginning of ESG.”
ESG-integrated company
Schroders is responsible for client assets worth €641.7bn, managed locally by 42 investment teams worldwide. On the amount of assets invested in ESG strategies, the fund house says it will reach the goal of becoming a fully ESG-integrated company by the end of 2020. However, the asset manager adds that integration varies by asset class. Moreover, ESG integration is not feasible or possible for a small number of strategies now, according to the fund house, which cites index trackers as an example.