ESG investing is moving faster than ever against a complex regulatory background. At The European Investor Summit, M&G Luxembourg’s Micaela Forelli says she’s thankful the rules aren’t too prescriptive and that firms have a duty to clearly explain ESG methodologies to clients, writes Nik Pratt.
To be successful in sustainable investment, you need the skills of a next-generation portfolio manager able to balance the need for investment returns against a growing list of ESG requirements and principles. And the patience of an adolescent’s parents.
These were the conclusions of a panel of sustainable investment professionals that spoke at the European Investor Summit held by Societe Generale Securities Services in Paris.
According to Lloyd McAllister, head of sustainable investment at Carmignac, the sustainable investment sector is going through its difficult teenage years. “There is so much going on right now, it just needs to settle down,” said McAllister.
One of the things going on is the European Commission’s (EC’s) Sustainable Finance Disclosure Regulation (SFDR), representing a pivotal moment in sustainable investment. The regime was introduced in 2021 as a way to combat greenwashing by introducing specific categories for sustainable funds (Article 8 and Article 9).
“This is the challenge we face. We have to perform financially and we also have to incorporate all of these different sustainability elements.”
However, by 2022, uncertainty over the definition of a sustainable investment had led many funds to be reclassified from Article 9 status to the less stringent Article 8 category.
In April, the EC stated that it was ultimately up to managers to set their own definition of sustainable investment, as long as they adhered to the three tests of ESG – contributing to an environmental or social objective, not causing significant harm to objectives, and meeting good governance practices.
The clarification also confirmed that the SFDR was principally concerned with disclosure and not labelling – something that was welcomed by the panellists.
“If investors were hoping for an easily packaged definition that could help with box-ticking, they will be sorely disappointed but that is not what we are looking for,” said McAllister.
“[The SFDR] has also created debate, which is good. It also stops the concern about herding behaviour – a tight definition that leads to huge capital inflows into a small part of the market would be a major market distortion. It is quite a painful process we are going through, but it is probably a good one.”
Complexity
His view was supported by other panellists. Micaela Forelli, managing director, Europe, M&G Luxembourg, was thankful that the EC had not been too prescriptive with its definition. However, the consequence is that an absence of standards will make the sustainable funds market more complex for investors.
“Now it is our duty to clearly explain to our clients what methodology we’re following and why and what is to be expected from each strategy,” she says.
It might yet get more complex for investors. A review of the SFDR is imminent, as is the introduction of the UK’s own measures, which look likely to be more akin to a labelling regime rather than disclosure. The question is whether that is better, asked the panel’s moderator, Denise Voss of LuxFlag, a labelling tool for sustainable investment products.
“Five years ago, oil companies’ plans were very different to what they are now. A lot of that came from engagement with investors.”
Labelling and transparency are two very different things, said Masja Zandbergen, head of sustainability integration at Robeco. “In Europe, there are a lot of local labels, all with their own requirements, which creates a lot of work – and piling more definitions on what sustainability is and more constraints when we are trying to produce returns. Plus, we have our own ideas and time spent on this is time we are not spending on our own research. I would prefer a label that we could use across borders,” said Zandbergen.
Voss, meanwhile, highlighted that EU ‘sustainability preferences’ contained in the Market in Financial Instruments Directive could drive investors to invest in financial products that finance companies which are already providing solutions for climate change and adaption. The investment universe needs to be wider and includes companies that are part of the problem, Voss feels, meaning investors may have to “hold their nose” when investing in some companies that are in transition. This is a critical part of sustainable investing, given the “massive” investment needed.
Dirty companies in transition
McAllister, at Carmignac, said: “We spend a lot of the time investing in dirty companies in transition – in mining, fast food, fossil fuels. Generally, clients don’t have a problem with that. They want to know what the plan is, if the plan is good and if there is evidence to support that.”.
The role of asset managers as stewards, able to hold their portfolio companies’ management teams and their transition plans to account, genuinely helps, said McAllister.
“Five years ago, oil companies’ plans were very different to what they are now. A lot of that came from engagement with investors. Things are moving so quickly in terms of energy transition that what you might think is really uncomfortable now will be a reality in a few years’ time. Therefore, there have to be negotiating points when you are engaging with companies,” added McAllister.
“Now it is our duty to clearly explain to our clients what methodology we’re following and why and what is to be expected from each strategy.”
Engagement is important, agreed Forelli, but it also has to come with investment discipline and a willingness to divest if companies’ transition plans and promises are not kept, especially if there is a lack of communication. But are we challenging the companies enough, and are we prepared to disinvest? And how does that engagement translate to the investment portfolio? Asked Zandbergen. After all, sustainable investment is still an investment.
This is where ESG analytics, if used correctly, have helped, said Zandbergen. “Since 2017, Robeco can show that the attribution of ESG analytics has helped our performance. It is not an exact science, but it gives us confidence that it is possible to take a systematic approach to sustainability. And this is the challenge we face. We have to perform financially, which is already very difficult, and we also have to incorporate all of these different sustainability elements. We need a portfolio manager 2.0 who understands all of this.”
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