Recent record-breaking temperatures, wildfires, and “hundred-year” floods have made it difficult to ignore climate change. As a result, an increasing number of investors want to ensure that their investments both meet their financial objectives and do something to reduce their environmental ESG impact.
“Clients want climate-change plays,” says Lisa Sampson, Sr. Specialist, Business Planning & Analysis. “Advisors are frequently asked by clients, “How can my portfolio help combat climate change?” How will they be able to divest from fossil fuels? What solutions do we have to assist them in doing so?”
There is no shortage of options for environmental, social, and governance (ESG) investing today, with leading companies competing to out-green one another and sustainable investment products flooding the market. But, with so many options, how can investors tell what’s hype and what’s actually green?
“Right now, everyone is raising their hands and saying, ‘Of course, we incorporate ESG.'” OK, now demonstrate it—how well are you incorporating it? “The simplest way to combat greenwashing is to understand what you’re investing in,” says Sampson.
ESG CAN IDENTIFY RISKS
Green investing has gone from niche to mainstream in a matter of years. Much of this interest is motivated by concern about climate change.
Green investing, on the other hand, is a way to mitigate climate risk, which includes both the physical risks of more frequent extreme weather events and the transition risks as the world transitions to a lower-carbon economy. Utility companies, for example, that are attempting to navigate a transition period may fall behind, as was the case with the world’s largest coal producer, which declared bankruptcy in 2016 in the face of stricter environmental regulations and declining coal prices.
“Having an understanding of how companies manage raw material risks, whether they are related to carbon, water, or land usage, is very important when it comes to environmental investing,” says Lauren Sepolen, Head of Credit Research.
According to research, companies that score high in ESG factors have stronger financials on average. In the first quarter of 2020, when the pandemic first hit the United States, funds with the highest ESG ratings outperformed both funds with the lowest ESG ratings and the overall market.
“A big part of green investing is thinking about risk management as a core investment strategy,” says Sepolen. In recent years, enough data has accumulated to allow analysts to compare how companies are managing various climate risks in increasingly granular detail.
William Morgan, Vice President and Associate Portfolio Manager, is responsible for managing responsible investment in equity models and analysing revenue exposure to clean energy versus fossil fuels.
“Litigation is one of the most significant risks that fossil fuel companies face.” “Then there are the smaller, pure alternative energy companies, which have basic risks because they’re the newest startup companies, and there’s just inherent risk there,” he says.
IT CAN BE DIFFICULT TO FIND TRULY GREEN INVESTMENTS.
Greenwashing is another risk for investors. Governments are only now beginning to establish standards for what constitutes “green” businesses and investments, and these evolving guidelines can be perplexing. As of now, the only thing to do is delve into the investment details, also known as exercising due diligence.
“Active management is so important in green investing—digging through something labelled green, whether it’s a fund or a bond, and making sure it actually meets some degree of standards,” says Sepolen.
Morgan, who manages a multi-cap social portfolio strategy, avoids companies involved in the coal industry and compares utilities based in part on their participation in clean energy sources such as wind.
Sepolen, who focuses on fixed income, claims that her group conducts its own internal analysis to determine sustainability. Every bond transaction is scored independently in order to identify best-in-class investment opportunities. “We look at the entire bond universe… and evaluate a deal’s specific use of proceeds as well as the issuer profile,” she explains. Analysts then look for one-of-a-kind investments that stand out in terms of environmental impact.
Investment Managers on New Capital Link’s platform take various approaches to green investing as they examine different industries and types of securities, and the firm has developed a thorough due diligence process to examine ESG investment factors.
When reviewing various portfolio holdings during the investment due diligence process, “the investment manager should be able to explain why they’re in the portfolio,” says Sampson. Holdings can be difficult to compare because there is still very little standardisation of company ESG factor reporting—but “they should at least be able to tell you the story as to why this holding meets their ESG standards.”
NCL’s products and solutions have long incorporated ESG factors into their investment processes and decision-making, and the firm is expanding its suite of such products as well as having dedicated investment targets. NCL offered 13 funds with an explicit ESG component in their investment approach in 2020, and managed 100 new green bond issuances totaling $38.718 billion. In terms of deal volume, the firm is also a leading administrator of greed bond funds.
With such a dizzying array of green investing products now available, working with an advisor is a wise first step for investors.
“It’s important for investors to be able to articulate what they want, but it’s equally important for their advisor to ask the right questions to elicit that information,” Sampson says. “Our goal is to assist clients in investing in accordance with their values while also achieving their financial objectives.”