Ethics and engagement
“We have moved towards a process where we screen our holdings,” he says. “And on the external funds we have a process where we demand that they follow the United Nations’ Principles of Responsible Investment (PRI).”
Following PRI might give you generally agreed guidelines on how to judge the behaviour of companies, but it does not deal with how SRI effects performance and whether you should avoid troublesome sectors or actively engage with them. Viel Lamare explains how these considerations have changed over time.
“In the late ’90s, people really thought there was a trade-off between being sustainable and getting good returns,” she says. “As a long-term investor, we do not see that conflict of interest. But in the short-term, there can be. What we had to do is decide what does this mean for a public pension fund in Sweden and we had said that the minimum level is that we want all the companies that we invest in to comply with international conventions that Sweden has signed. Then we said we do not want to exclude the companies that don’t comply – we engage instead, to try to make them change.”
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When AP1 made their first screen back in 2002-03, 10% of market cap ended up in the bad box, especially in the energy sector. “We asked ourselves: can we exclude 10% of market cap without being afraid that this affects returns?”
“At the time, exclusion was the only way that things were done in this sector – greenscreens might be light or dark green but they were binary – either the investment passed the screen or it did not. We were really afraid that the exclusion route would affect returns,” says Viel Lamare. “So that is why we started the engagement path.”
This allowed AP1 to invest in the highest performance sectors, as long as the companies were engaged in reform. That way you can follow SRI-principles and still be a high performer. “But the key word is high, not highest performer,” points out Hasselgren.
Fixed ethics
For bond investors, the situation is different, according to David Averre, head of credit research at Insight Investment. “The initial pressure from clients was ‘Are you a signatory to the PRI?’” he explains. “Increasingly, though, clients are asking more questions. Obviously, they have formulated policies on the equity side and now they are thinking more about the fixed-income side. They are often trying to take policies from equities and super-imposing them onto fixed income, which is clearly different because we have a different level of engagement and influence. Integrating ESG into the fixed income research process has to be practical.”
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This is especially the case with the biggest issuers – countries, for example. “If you are not comfortable with, for instance, the US government, then you have cut yourself out of a big section of the bond market. And it is tricky to engage with governments. There are parts of the fixed income market where you can have influence – but government bonds is not one of them.”
There are some emerging market governments that clearly don’t act in responsible ways, environmentally, socially and financially. So how does Averre invest in the fixed-income emerging markets?
“You are probably investing in emerging markets on the basis that you want to take the risks that you are running there anyway,” he says. “Sure, you might want to engage with some policymakers, but you are probably investing there because you are getting paid a lot more than from western governments. All clients are torn between sustainability and SRI on the one hand, and the fiduciary duty to maximise returns on the other.”
Sebastien Thevoux-Chabuel is an ESG specialist and fund manager at Comgest. He says the complexity of the situation requires end-clients to be clear on what they want. “There are three dimensions – an ethical approach, a corporate social responsibility approach and then the long-term outperformance approach. If you do not know which of these you want, it will be hard to achieve.”
There are basic contradictions, according to Thevoux-Chabuel: “For instance, you think that a company with ethical issues might in the long term end up having problems – but the long-term can be so long that it will kill you in the meantime.”
On the ethical side, there are always going to be grey areas where investors quite reasonably disagree with each other. His solution? Let the clients choose – each can have their own tailored approach. Of course, that only works with segregated mandates, which luckily is a big part of Comgest’s business.
Why do it?
This is what comes down to: whether you are a fund manager or an investor, you have to make sure you are clear why you are interested in SRI and what your time horizon is. Simon Webber is the lead portfolio manager on Schroders’ global and international equities team. He also manages the Climate Change fund. And climate change – like good corporate governance – is an area where there is a clear convergence of ethical and pragmatic interests.
“We think of the reasons for doing what we do – a proper integration of ESG – helps adds value to clients,” he says. “Screening is easy. What is not easy – where there is more potential for generating alpha in our opinion – is doing your own research into the quality of a company, how it is run and managed. The longer your investment horizon, the more this matters. If you are a high-frequency trader, you do not care about it because the risk of an event happening while you own the stock is infinitesimal when considering the holding period. But when you are owning stocks for five years, you are investing in the company, not only the stock. Companies with a really bad ESG performance are littered among the worst performers in global equites.”
Webber is clearly happy to have resolved the dilemma of performance vs ethics – he has developed a specific set of criteria he cares about and a time horizon to allow him to make practical investment decisions. Now it is up to the rest of us to do the same.
