Wealth Management: Mosaique Insights – Today's investment agenda
Kevin Gardener, Global Investment Strategist
How investment objectives are evolving to focus on long-term sustainability
Investors' objectives are changing, and investment processes are responding. In particular, it feels as if attitudes towards environmental, social and governance-related (ESG) issues, particularly those related to climate change and sustainability, have shifted decisively in the last year. This means that we can no longer assume that total return - net of inflation - is the only investment goal our clients care about: increasingly, clients want those inflation-beating returns to be delivered without doing environmental or societal damage.
This debate is likely to be accelerated by the recent COVID-19 global lockdown and the way it has challenged our way of doing business, consuming goods and propensity to travel (see box 'Sobering statistics').
The public mood may be overstating our global predicament when it comes to climate change. In contrast to what the activists are saying, scientists are not talking of extinction events, or anything close. Nor is it the case that society has ignored the issue to date.
Intergovernmental initiatives can be frustratingly slow and conjectural, but significant practical changes have already been made (not least the earlier tackling of CFCs,1 and more recently the growth in renewable energy sources and in carbon offsetting and trading).
One of the by-products of today's low interest rates is an increased value placed on the welfare of future generations. Indeed, if we take some of Europe's longer-dated negative yields at face value, we may implicitly be valuing their welfare more highly than our own.
Nonetheless, the public is less willing to wait and find out. Politicians (with some high-profile exceptions) are going to have to do more, and investors understandably want to see how their portfolios score on a range of ESG metrics. Some high-profile business leaders are already reacting to the shift in opinion.
Last year, the US Business Roundtable publicly changed its stance, relegating the pursuit of shareholder value and promoting instead the interests of wider stakeholders. In February, Amazon's CEO Jeff Bezos pledged a personal $10 billion donation to climate change research.
We think 2019 may prove to have been something of a watershed in this respect. An ESG-informed investment process is no longer optional for wealth managers and advisers. Instead, we find that our clients increasingly expect it to be part of the central proposition
As yet there is no single accepted best practice approach to doing so. As discussed in The language of responsibility, there are many different ways portfolio managers might respond to the need to consider, and act upon, ESG concerns.
This is partly because there are few clear boundaries between environmentally friendly (and ESG-friendly) investments and others. No business operates in a vacuum. For example, aiming to mitigate the impact of climate change by avoiding all carbon-fuel-using activities would leave very few eligible companies.
Air pollution kills about 1.1 million people in China alone every year. It is estimated that the fall in emissions during China's January/February COVID-19 social lockdown earlier this year saved around 20 times more lives in China than have been lost due to infection from COVID-19.2
Drawing the line
Where in the production chain should portfolio managers draw the line? Do electric vehicles reduce overall emissions, for example, or simply shift the carbon frontier further upstream (to generating and transmission companies)? Do we need to consider how efficiently retailers' distribution networks function or the carbon footprints of technology companies' customers? If we want to avoid armaments or tobacco manufacturers, do we want to avoid their main suppliers too?
The lack of clear boundaries is not confined to the businesses and activities being considered for investment, but extends to more practical implementation concerns too. For example, should an environmentally aware investor aim to hold only the 'greenest' businesses, or is it enough to avoid the biggest offenders?
These unavoidable ambiguities may be reduced for investors and portfolio managers by turning to independent third parties. Increasingly, the major index providers and investment consultancies are responding to client demand by offering data-based rankings and benchmarks that facilitate an objective screening and selection process. Clients seem to recognise that the search for an elusive perfection should not obstruct the adoption of a better process than those used in the past - that this is one of those areas in which we should not let the best become the enemy of the good.
The costs of environmentally tilted portfolios are uncertain. The traditional argument is anything that restricts the investment universe is likely to restrict potential returns too. In practice, however, some of the most exposed businesses - such as oil and mining companies - may be intrinsically less attractive as longterm investments (that is, not just because of their carbon footprints) anyway, in which case avoiding them may not hurt long-term returns.
Similarly, when it comes to wider ESG issues, the costs of focusing on those companies with the best corporate governance practices, for example - or the costs of avoiding those with the worst - may be non-existent from the start. Arguably, businesses that observe best practice when it comes to protecting shareholder or workforce rights will be the better positioned to meet future strategic challenges, and worth more anyway.
Meanwhile, the construction costs of creating appropriately tilted ESG benchmark indices will likely fall over time, as have those of other semipassive investment strategies to date.
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A pragmatic approach to building portfolios
At Rothschild & Co Wealth Management, we are reflecting our clients' wishes by incorporating ESG concerns explicitly in the selection of sectors and stocks when building portfolios. As our colleagues explain in the following articles, we will not follow a rigid template-driven process, or hold ourselves accountable to a single ESG benchmark, but instead follow a more pragmatic approach. Some sectors will be excluded from consideration, and all other securities will be screened and appraised for their suitability - particularly in the environmental dimension - using some of that third-party expertise.
In this way, while we do not have a single prescribed list, or a new benchmark, we believe we will be able to satisfy clients' wishes to monitor and limit their portfolios' exposure to environmentally and socially damaging businesses, and we think we can do so without incurring materially higher costs. Doubtless our approach will evolve - as will society's.
2Calculations by Marshall Burke of Stanford University, Department of Earth System Science.