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The implementation of ESG in portfolios and the evolution of ESG reporting

We continue this series with Tomas Hildebrandt, Senior Portfolio Manager at Evli, and Janne Kujala, Head of Nordic Equity, to discuss implementation of responsible investments across funds and investment spaces.

Article also available in : English EN | français FR

How to see through green washing before investing?

Companies definitely have an incentive to do green washing, which means that they often communicate on doing good things for the environment, but don’t actually do anything concrete. And as it is with a lot of corporate communications, the language used is very promotional. Investors just have to cut through all that. For the easy investor, it’s easy to just buy the green wash story, but if an investor really wants to impact and do some deeply responsible investing, they have to do more.

Over time, investor gains the experience of seeing through all that. One way of making certain whether companies are doing anything, or if this is just all talk and no walk, is to see whether they have someone in charge of their ESG strategy, and preferably in the executive group. Corporate governance is really the key in checking if companies are just looking good or if they are doing good. When you take a look at executive committees, it is also important to see if they have reporting on ESG matters at a company level. That is the way to make sure that there is progress going on in the companies and that they are actually following up on what they claim to be doing.

What are the challenges of ESG exclusion and integration?

A systematic approach regarding ESG and exclusion can produce systematic under or over performance, but it can always be compensate with something else in the portfolio. On the contrary, it can be much more difficult to compensate under or over performance linked to ESG factors with an ad-hoc strategy. Exclusions can have effects on the relative performances of a portfolio because of different events, but we are convinced exclusions are positive on the long run.

Regarding the evolution of demands regarding ESG integration, it has grown stricter and the bar has been set higher over time. But it’s a good thing for portfolio managers, because it enables them to evolve in a more responsible way. Plus, we now have access to more information about the company in portfolios, such as emission and gender balance reports. Therefore investments processes have to take those new data into account. ESG is evolving all the time and as an asset manager, you have to be active on different kinds of issues and fronts, take part in different investor initiatives that brings more information on responsible investing. It’s a work always in progress that aims to have an impact on the companies and on the real underlying issues, not only at the portfolio level.

Does responsible investing and ESG narrow the investment spaces?

A decade ago, the ESG and responsible investing approach was taking its baby steps. And today we see three types of clients positioned on those issues. The first group are those for whom the issue is really irrelevant, they’re only looking for returns. They’re not that interested in ESG issues. But, that’s a minority today. The second and largest group are clients who are looking for responsibility and ESG more from a risk management perspective and typically for guarding against reputation risks. Then the third group are more faith-based investors, who have very clear issues that they want to take into account in their investments and in their portfolios.

To address those clients needs, portfolio managers have to follow all positions and that’s why transparency is key. Therefore, it’s essential to have access to all the data and to have the possibility to go through investment processes. And as responsible investment can be complex, you could say that there are several shades of grey – or green, the best is to offer a solution that fits most of the clients. If an investor wants to have specific exclusions or some specific tilts in the portfolio, portfolio managers have to adapt and look for other solutions.

But does that means it narrows the investment space? Not necessarily, because most companies nowadays are taking ESG very seriously. There are, of course, industries that inherently are more problematic. But what’s important is that the companies themselves address these issues and do better within the confines of what can be done in their particular business. Take for example very high emitting industries such as steel making or cement factories: those companies will work to have smaller emissions in the future. Portfolio managers will look at what companies can do within the field of ESG in the future, not only what they’re reporting today. 
 So, when portfolio managers implement responsible strategies, it always narrows investment space to some extent. It’s quite obvious because it takes an active view on the markets. Today, there are many different techniques to mitigate this narrowing such as different factors strategies that can optimise a tracking error and practise exclusions with a narrower space. But, in the end, it’s really a question of the beliefs of investors. The main point being that most of us think that responsible companies do better in their business. This should lead to better earnings and therefore to a better performances.

We strongly believe that an implemented and thought-after ESG strategy has tangible and positive effects on absolute and relative performances. More and more studies show that implementing responsible strategies or ESG strategies don’t harm performances. In recent years, we have mostly seen that the companies that run into trouble regarding responsibility are hammered in the markets quite quickly. ESG investing is precisely about taking into account all the risks but also the possibilities or opportunities. And investors can always look for new opportunities in companies revising their strategies.

Janne Kujala , Tomas Hildebrandt 22 February

Article also available in : English EN | français FR

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