As we describe daily at ESG Today, sustainability is emerging as the defining investment trend of the decade, driven primarily by an emerging social consciousness among investors, and a renewed appreciation among owners of capital that the concept of risk extends beyond the direct financial consequences of project-level decisions. Sustainable investing is a broad discipline, covering multiple aspects of the investment process, from financing projects using sustainability-linked financial instruments, to risk avoidance by focusing on favorably ESG-rated companies, to proxy voting to influence the behavior of companies.

Not surprisingly, as investor demand for sustainability-themed action has grown, this has often taken the form of pressure building on influential investment managers to push for change at the company level. Thus, in recent months, the market has seen investing giants like BlackRock and State Street publicly declare to actively embed sustainability considerations in their investment processes, including using proxy voting power to push for change, and to divest from companies that did not fit the requisite ESG profile. These are not simple decisions for the asset managers, who, as investment stewards, must first and foremost take their fiduciary duties to their clients into consideration, and align their activities with these considerations.

Among the largest investment managers, Vanguard – a long-time champion of investment stewardship – has been one of the most circumspect regarding its approach to taking action on sustainability issues…until now. Vanguard has published a report outlining its expectations for companies and their boards regarding climate risk governance, and an accompanying report detailing examples of recent proxy voting positions the company has taken to support this position.

The approach Vanguard describes is characteristically measured. Outlining the firm’s proxy voting process regarding climate-related shareholder proposals, Vanguard details a process of first determining the materiality of the risk the climate issue has on the company, and the scope of actions being presented in the proposals, with a preference given to increased disclosure and target setting. Vanguard describes the process as follows:

“We carefully analyze every climate-related proposal. At companies where climate matters present material risks, the funds are likely to support shareholder proposals that seek reasonable and effective disclosure of greenhouse gas emissions or other climate-related metrics. The funds may also support proposals that ask companies to pursue climate risk mitigation targets, such as those aligned to the goals of the Paris Agreement.

“The funds are unlikely to support proposals requiring companies to make specific operational changes, such as phasing out a business or product; we generally view such proposals as overly prescriptive.”

The firm tends to avoid using the voting process to push for direct operational changes, preferring to use direct engagement to address these issues:

“Vanguard has had a wider and deeper impact on climate-related matters through our direct engagements with portfolio companies. Last year, we spoke with more than 250 companies in carbon intensive industries. We also regularly talk about climate risk with companies beyond those in the top carbon-producing and carbon-consuming sectors. Few companies will be entirely insulated from the impacts of climate change.”

Vanguard goes on to lay out its expectations for companies and their boards. First and foremost, the firm expects appropriate oversight by companies of climate risks, with proper disclosure that enables investor insight into company decision-making and management of climate-related risks and opportunities.

At the board level, Vanguard expects long-term strategic considerations to take into account not only the physical risk aspect of climate change, but the transition risk as well, including regulatory changes, technological disruption and shifting consumer preferences. Vanguard appeals for “climate-competent” boards that include directors with relevant climate or business adaptation experience, seek diverse perspectives such as input from various geographies or sectors, and engage in ongoing education with experts, stakeholders and industry groups.

Vanguard’s newly published guidelines for its stance on climate risk governance lays out a measured  approach that, on the surface, is less aggressive than its peers, but may ultimately may prove highly effective, one that seeks a path in line with its view of its fiduciary duties, while setting clear, specific expectations of company management and boards in addressing this growing and disruptive risk.

Click here to see the new documents published by Vanguard.  

Survey uncovers growth drivers, regional differences in ESG investing

A recent survey by Macquarie Infrastructure and Real Assets (MIRA) clearly shows a growing interest in ESG by professional investment managers. MIRA’s survey summarizes responses from 150 real asset investors, representing over $20 trillion of assets globally. Some of the key findings include an intensifying interest in sustainable investing, high conviction that an ESG strategy can improve returns, and some revealing regional differences in the resources and attention managers allocate to ESG.

Greater focus on ESG

The MIRA survey found that investors have been increasing their focus on ESG, and intend to continue to do so. 58% of investors report having increased their ESG focus over the past 5 years, while an impressive 91% expect it to increase further over the next 5 years. Some investors expect a long-term convergence between ESG and traditional investing, as explained by one respondent to the survey:

“There will be even less of a divide between “traditional” financial matters and ESG matters. They will become more entangled, with one key driver being the need to invest in, for example, climate change solutions and Sustainable Development Goal solutions.”

Better returns with ESG

Most survey respondents expressed their belief that including ESG considerations can boost investment performance, with 78% supporting the proposition that having a good sustainability strategy improves returns, although 21% indicated that it can actually sacrifice returns. Despite this result, almost two thirds of respondents indicated they are not yet using active ESG assessment in their decision-making.

Exclusion and Active ESG strategies

Investors responding to the survey indicated the use of both exclusion strategies (such as avoiding specific companies or sectors) as well as active strategies (allocating funds to ESG-benefiting sectors). The most commonly categories for exclusion included weapons and defence, Labor/human rights violations, and environmental violations. The most common actively pursued ESG themes are Renewable Energy, Environmental Impact, and Social Impact.

Regional differences

One of the most interesting findings revealed by the survey is the contrast between regions in resources and attention firms allocate to ESG. 72% of respondents from EMEA and 71% from Australia reported having a dedicated ESG function in their firms, compared to only 24% of those in the Americas and 21% in Asia. Similarly, 74% of EMEA investors and 95% in Australia reported having an ESG policy, while only 48% in the Americas and 58% in Asia have one.

ESG growth drivers

MIRA’s survey revealed not only that ESG-driven investing is growing, but also uncovered several of the drivers of that growth. In the commentary section of report discussing the survey findings, MIRA indicated that one of the key reasons for the growth in ESG investing is the increased perception of risk, with investors becoming increasingly conscious of their own reputations and brands, driving them to avoid controversial investments. Other drivers include the belief that sustainable investing improves returns, public policy promoting sustainability and improved ESG disclosure, as well as broader general awareness of environmental, social and governance issues.

As we have reported at ESGToday, BlackRock, the world’s largest investment manager, has been particularly active on boosting its sustainability profile over the past few days. Last week, the company joined Climate Action 100+, a network of investment managers dedicated to promote cleaner practices among large corporations. Subsequently, BlackRock CEO Larry Fink published a letter to CEOs focused on climate change and putting sustainability at the core of BlackRock’s investment process.

We believe BlackRock’s new focus on sustainability marks the beginning of a fundamental shift in the investment management universe, namely the emergence of ESG as the most significant and pervasive investment theme of the next decade.

As Mr. Fink points out in his letter to CEOs, climate change will have major implications on economic growth and prosperity, yet it is “a risk that markets to date have been slower to reflect.” We believe this to be true not just of environmental stewardship, but of all ESG risks. ESG issues, from climate change, to rising pharmaceutical pricing, to workplace safety, are increasingly front and center in media, politics, and social media… yet are all but absent in the decision-making process of professional investment managers. But we believe this is beginning to change.

In our experience, this change takes place in several stages.

First, professional investment managers become aware of the relevance of ESG issues by catering to the requests of socially-conscious clients, who don’t want to be funding companies or projects that don’t align with their values. Consider, for example, a charitable foundation that wants to avoid owning fossil fuel-producing assets.

From there, ESG awareness becomes a process of risk management – such as avoiding companies that are more likely to suffer losses due to weak governance, or with exposure to environmental fines.

Finally, we believe that ESG investing will become an investment theme that portfolio managers will pursue actively – looking for companies that will benefit from these evolving trends. As stated in the BlackRock letter:

“These questions are driving a profound reassessment of risk and asset values. And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself. In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.”

As investors, we know that significant reallocation of capital creates significant opportunities. We believe the best forward-looking managers will be able to use ESG strategies, not just to avoid risk, but to create superior long-term returns, making ESG investing one of the most powerful investment themes in the coming years.