One in five professionally managed dollars in the US is now invested with environmental, social and governance (ESG) factors in mind, according to the latest data from the US SIF Foundation. Its European counterpart Eurosif finds that more than half of assets in Europe can be categorised as “sustainable and responsible investments” (SRI). Investors managing more than $60 trillion, perhaps half of the global pool of managed assets, have signed up to the UN-backed Principles for Responsible Investment (PRI).
Three impressive statistics – and three different acronyms, covering a wide range of investment approaches, and causing considerable confusion in the marketplace.
So how should investors make sense of the responsible investment alphabet soup?
Part of the problem is that many of the acronyms and expressions used lack an agreed definition, and are often used casually or interchangeably. But sloshing within the soup are terms and approaches that have more precise meanings, and which can be used to understand exactly how a self-described responsible or ESG investor approaches the business of investing.
As a starting point, SRI, responsible investment, and ESG investing can be considered umbrella terms that cover a multitude of approaches. Put simply, they involve some consideration of environmental, social, ethical and/or governance issues in the selection and management of investments and typically, they imply a relatively long-term investment horizon.
As is clear from the above, ethical investment is a sub-set of responsible investment. The approach – avoiding companies whose activities conflict with an investor’s values – was borne out of campaigns against apartheid in South Africa in the 1980s, and several religious groups also adopted a similar approach and pioneered the modern SRI industry. For that reason, and because many retail SRI products still take an ethical investment approach, many people continue to conflate responsible investment or SRI with ethical investment.
However, ethical investing is very much a sub-set of today’s responsible investment world. Ethics are subjective, and the investment approach – excluding companies and often entire industry sectors, such as tobacco, gambling and defence, adds to a portfolio’s volatility and risks underperformance compared with the market as a whole. Ethical investors are commonly understood to be prepared to accept this risk of underperformance as a price worth paying to invest in line with their values.
For most responsible investors, however, the starting point is that an understanding of ESG issues can help improve investment returns, by identifying risks and capturing opportunities that might be overlooked by the wider market.
Such an approach can be characterised as ESG integration (as opposed to the somewhat vaguer ‘ESG investing’). It involves investors integrating a rigorous assessment of ESG factors with their existing financial analysis, with a view to generating investment outperformance.
This integration is the first of the six principles to which PRI signatories commit. There is, of course, a range of options as to how that ESG analysis is used to inform investment decisions.
One approach is best-in-class investing, where ESG scores are used to identify the top ESG performers in each industry sector. This has the advantage of allowing managers to construct portfolios that mirror the mix of industry sectors found in the wider market, preventing too much divergence in returns from market benchmarks. The downside, however, is that best-in-class investing tends to focus on how a company is run, ignoring what it produces. For example a well-run producer of gas guzzling SUV vehicles might score more highly than a manufacturer of hybrid or electric vehicles.
Another danger with ESG integration is that it can pay insufficient attention to the ‘materiality’ of various ESG factors. Consumer protection issues are much more important than climate change for the performance of a retail bank, for example, while strong anti-bribery policies are a higher priority for a pharmaceutical firm than energy efficiency. Failure to control for materiality can lead to perverse outcomes.
Meanwhile, larger companies tend to have more developed ESG policies and processes, allowing them to score more highly than their actual performance might suggest. This has led some to question the usefulness of ESG fund ratings for companies (and investment funds, for that matter) offered by a growing number of service providers.
Incorporating ESG risks and opportunities
At Impax we use ESG analysis as one step of our rigorous investment process to identify the providers of solutions to the pressing environmental problems we face as a result of population growth, changing demographics and increasing consumption. This approach could be categorised as thematic ESG investing, and it can be particularly successful when applied to under-researched mid- and small-cap companies.
There is also another responsible investment strategy – impact investing that is gaining traction as an allocation style, particularly within the wealth market, as families and younger inheritors of wealth seek to align their investments with their values. We have three strategies across listed equities, as well as renewable power generation and sustainable property in real assets which tend to appeal to this growing audience. Our investment process directs capital towards companies and/or real assets with quantifiable environmental benefits, in addition to financial returns.
Listed equity products have been slow to adopt a sophisticated approach to positive impact measurement and typically look only at ESG risk mitigation, whether through negative screening or incorporating aspects of ESG strategies. Impax is one of the first take the language and quantitative evidence of positive impact investing to a listed equity strategy. The first step in our investment process is to establish that a company generates at least 20 per cent of its revenues from environmental market exposure (on average across the portfolio this is currently around 60 to 80 per cent). It is this pure play approach that delivers a truly differentiated portfolio and enables measurement of the positive environmental impact. Such an assessment allows us to demonstrate to our investors the real-world positive environmental outcomes of our investment decisions, and track progress over time.
[We also see a growing number of investors are considering measuring impact, encouraged by the launch in 2015 of the UN Sustainable Development Goals (SDGs), 17 objectives to tackle global social, environmental and development challenges. However, because the SDGs are broad in scope – one metric is for job creation, for example – there is a risk that some investors will seek to claim that business-as-usual investing has helped deliver against the SDGs. We think that such claims should be met with scepticism: intention is as important as outcome for investors claiming to be impact investors.]
So much for defining our terms. What does all this mean for investment performance? For ethical investing, the calculation is clear: restricting the size of the investible universe increases the volatility of returns compared with the broader market. For ESG integration, however, our experience and the emerging academic consensus is that investing responsibly need not sacrifice returns and, in the majority of cases, and particularly over the longer term, integrating ESG factors provides investors with additional information and insight, helping them to outperform.
Written By Lisa Beauvilian, Head of Sustainability & ESG, Director
Lisa joined Impax in 2010 and is responsible for environmental policy and legislation investment research and non-financial or Environment, Social and Governance (ESG) analysis.
She started working in the financial industry in 1999 and previously worked as Executive Director in the Investment Management Division of Goldman Sachs International. Lisa has also worked as an independent consultant focusing on environmental policy research and analysis. She is a Trustee at the International Institute of Environment and Development (“IIED”). Lisa has an MSc in Environment and Development from the London School of Economics and an MSc in Finance from the Hanken School of Economics in Finland.
2017 Was the Most Expensive Year Ever for U.S. Natural Disaster Damage
Devastating natural disasters dominated last year’s headlines and made many wonder how the affected areas could ever recover. According to data from the U.S. National Oceanic and Atmospheric Administration (NOAA), the storms and other weather events that caused the destruction were extremely costly.
Specifically, the natural disasters recorded last year caused so much damage that the associated losses made 2017 the most expensive year on record in the 38-year history of keeping such data. The following are several reasons that 2017 made headlines for this notorious distinction.
Over a Dozen Events With Losses Totalling More Than $1 Billion Each
The NOAA reports that in total, the recorded losses equaled $306 billion, which is $90 billion more than the amount associated with 2005, the previous record holder. One of the primary reasons the dollar amount climbed so high last year is that 16 individual events cost more than $1 billion each.
Global Warming Contributed to Hurricane Harvey
Hurricane Harvey, one of two Category-4 hurricanes that made landfall in 2017, was a particularly expensive natural disaster. Nearly 800,000 people needed assistance after the storm. Hurricane Harvey alone cost $125 billion, with some estimates even higher than that. So far, the only hurricane more expensive than Harvey was Katrina.
Before Hurricane Harvey hit, scientists speculated climate change could make it worse. They discussed how rising ocean temperatures make hurricanes more intense, and warmer atmospheres have higher amounts of water vapor, causing larger rainfall totals.
Since then, a new study published in “Environmental Research Letters” confirmed climate change was indeed a factor that gave Hurricane Harvey more power. It found environmental conditions associated with global warming made the storm more severe and increase the likelihood of similar events.
That same study also compared today’s storms with ones from 1900. It found that compared to those earlier weather phenomena, Hurricane Harvey’s rainfall was 15 percent more intense and three times as likely to happen now versus in 1900.
Warming oceans are one of the contributing factors. Specifically, the ocean’s surface temperature associated with the region where Hurricane Harvey quickly transformed from a tropical storm into a Category 4 hurricane has become about 1 degree Fahrenheit warmer over the past few decades.
Michael Mann, a climatologist from Penn State University, believes that due to a relationship known as the Clausius-Clapeyron equation, there was about 3-5 percent more moisture in the air, which caused more rain. To complicate matters even more, global warming made sea levels rise by more than 6 inches in the Houston area over the past few decades. Mann also believes global warming caused the stationery summer weather patterns that made Hurricane Harvey stop moving and saturate the area with rain. Mann clarifies although global warming didn’t cause Hurricane Harvey as a whole, it exacerbated several factors of the storm.
Also, statistics collected by the Environmental Protection Agency (EPA) from 1901-2015 found the precipitation levels in the contiguous 48 states had gone up by 0.17 inches per decade. The EPA notes the increase is expected because rainfall totals tend to go up as the Earth’s surface temperatures rise and additional evaporation occurs.
The EPA’s measurements about surface temperature indicate for the same timespan mentioned above for precipitation, the temperatures have gotten 0.14 Fahrenheit hotter per decade. Also, although the global surface temperature went up by 0.15 Fahrenheit during the same period, the temperature rise has been faster in the United States compared to the rest of the world since the 1970s.
Severe Storms Cause a Loss of Productivity
Many people don’t immediately think of one important factor when discussing the aftermath of natural disasters: the adverse impact on productivity. Businesses and members of the workforce in Houston, Miami and other cities hit by Hurricanes Harvey and Irma suffered losses that may total between $150-200 billion when both damage and sacrificed productivity are accounted for, according to estimates from Moody’s Analytics.
Some workers who decide to leave their homes before storms arrive delay returning after the immediate danger has passed. As a result of their absences, a labor-force shortage may occur. News sources posted stories highlighting that the Houston area might not have enough construction workers to handle necessary rebuilding efforts after Hurricane Harvey.
It’s not hard to imagine the impact heavy storms could have on business operations. However, companies that offer goods to help people prepare for hurricanes and similar disasters often find the market wants what they provide. While watching the paths of current storms, people tend to recall storms that took place years ago and see them as reminders to get prepared for what could happen.
Longer and More Disastrous Wildfires Require More Resources to Fight
The wildfires that ripped through millions of acres in the western region of the United States this year also made substantial contributions to the 2017 disaster-related expenses. The U.S. Forest Service, which is within the U.S. Department of Agriculture, reported 2017 as its costliest year ever and saw total expenditures exceeding $2 billion.
The agency anticipates the costs will grow, especially when they take past data into account. In 1995, the U.S. Forest Service spent 16 percent of its annual budget for wildfire-fighting costs, but in 2015, the amount ballooned to 52 percent. The sheer number of wildfires last year didn’t help matters either. Between January 1 and November 24 last year, 54,858 fires broke out.
2017: Among the Three Hottest Years Recorded
People cause the majority of wildfires, but climate change acts as another notable contributor. In addition to affecting hurricane intensity, rising temperatures help fires spread and make them harder to extinguish.
Data collected by the National Interagency Fire Center and published by the EPA highlighted a correlation between the largest wildfires and the warmest years on record. The extent of damage caused by wildfires has gotten worse since the 1980s, but became particularly severe starting in 2000 during a period characterized by some of the warmest years the U.S. ever recorded.
Things haven’t changed for the better, either. In mid-December of 2017, the World Meteorological Organization released a statement announcing the year would likely end as one of the three warmest years ever recorded. A notable finding since the group looks at global land and ocean temperature, not just statistics associated with the United States.
Not all the most financially impactful weather events in 2017 were hurricanes and wildfires. Some of the other issues that cost over $1 billion included a hailstorm in Colorado, tornados in several regions of the U.S. and substantial flooding throughout Missouri and Arkansas.
Although numerous factors gave these natural disasters momentum, scientists know climate change was a defining force — a reality that should worry just about everyone.
How to be More eco-Responsible in 2018
Nowadays, more and more people are talking about being more eco-responsible. There is a constant growth of information regarding the importance of being aware of ecological issues and the methods of using eco-friendly necessities on daily basis.
Have you been considering becoming more eco-responsible after the New Year? If so, here are some useful tips that could help you make the difference in the following year:
1. Energy – produce it, save it
If you’re building a house or planning to expand your living space, think before deciding on the final square footage. Maybe you don’t really need that much space. Unnecessary square footage will force you to spend more building materials, but it will also result in having to use extra heating, air-conditioning, and electricity in it.
It’s even better if you seek professional help to reduce energy consumption. An energy audit can provide you some great piece of advice on how to save on your energy bills.
While buying appliances such as a refrigerator or a dishwasher, make sure they have “Energy Star” label on, as it means they are energy-efficient.
Regarding the production of energy, you can power your home with renewable energy. The most common way is to install rooftop solar panels. They can be used for producing electricity, as well as heat for the house. If powering the whole home is a big step for you, try with solar oven then – they trap the sunlight in order to heat food! Solar air conditioning is another interesting thing to try out – instead of providing you with heat, it cools your house!
2. Don’t be just another tourist
Think about the environment, as well your own enjoyment – try not to travel too far, as most forms of transport contribute to the climate change. Choose the most environmentally friendly means of transport that you can, as well as environmentally friendly accommodation. If you can go to a destination that is being recommended as an eco-travel destination – even better! Interesting countries such as Zambia, Vietnam or Nicaragua are among these destinations that are famous for its sustainability efforts.
3. Let your beauty be also eco-friendly
We all want to look beautiful. Unfortunately, sometimes (or very often) it comes with a price. Cruelty-free cosmetics are making its way on the world market but be careful with the labels – just because it says a product hasn’t been tested on animals, it doesn’t mean that some of the product’s ingredients haven’t been tested on some poor animal.
To be sure which companies definitely stay away from the cruel testing on animals, check PETA Bunny list of cosmetic companies just to make sure which ones are truly and completely cruelty-free.
It’s also important if a brand uses toxic ingredients. Brands such as Tata Harper Skincare or Dr Bronner’s use only organic ingredients and biodegradable packaging, as well as being cruelty-free. Of course, this list is longer, so you’ll have to do some online research.
4. Know thy recycling
People often make mistakes while wanting to do something good for the environment. For example, plastic grocery bags, take-out containers, paper coffee cups and shredded paper cannot be recycled in your curb for many reasons, so don’t throw them into recycling bins. The same applies to pizza boxes, household glass, ceramics, and pottery – whether they are contaminated by grease or difficult to recycle, they just can’t go through the usual recycling process.
People usually forget to do is to rinse plastic and metal containers – they always have some residue, so be thorough. Also, bottle caps are allowed, too, so don’t separate them from the bottles. However, yard waste isn’t recyclable, so any yard waste or junk you are unsure of – just contact rubbish removal services instead of piling it up in public containers or in your own yard.
5. Fashion can be both eco-friendly and cool
Believe it or not, there are actually places where you can buy clothes that are eco-friendly, sustainable, as well as ethical. And they look cool, too! Companies like Everlane are very transparent about where their clothes are manufactured and how the price is set. PACT is another great company that uses non-GMO, organic cotton and non-toxic dyes for their clothing, while simultaneously using renewable energy factories. Soko is a company that uses natural and recycled materials in making their clothes and jewelry.
All in all
The truth is – being eco-responsible can be done in many ways. There are tons of small things we could change when it comes to our habits that would make a positive influence on the environment. The point is to start doing research on things that can be done by every person and it can start with the only thing that person has the control of – their own household.