Green is good

Despite the current market turmoil, it seems the focus on sustainable investment is getting ever stronger.

US president Barack Obama has made green investment projects a cornerstone of his plans to revitalise the ailing US economy. More and more investors and asset managers are signing up to the UN Principles of Responsible Investment. The Irish government is reconsidering introducing ethical investment guidelines for its National Pensions Reserve Fund. And the forthcoming UN Copenhagen climate change summit has pushed climate change to the top of the political agenda.

The belief among pension funds that sustainable investment is a source of value over the long term seems to be well established but that has in many cases had to come second to more immediate concerns. 

Some institutions have delayed sustainable investment projects for the time being. “We’ve had a handful of cases where projects about to start were put on hold, but not cancelled,” says Mercer principal Danyelle Guyatt. “We’ve also had some clients who have gone to the other extreme – they’re starting to think strategically that sustainable investment could be part of the solution to promote a more sustainable capital markets system. But for the smaller corporate pension plan investing in sustainable investment isn’t a priority; they are dealing with the crisis in funding shortfall.”

One reaction to the crisis has been for pension funds to reduce risk in their portfolios by reducing their equity allocation, which has in some cases led to a reduction in allocations to sustainable investments.

By contrast F&C reports a huge surge in interest in demand for its responsible investment overlay business, with institutional investors appointing F&C to vote all their shares and represent their interests as company shareholders in dialogue with companies.

“That business has just exploded,” says F&C’s head of governance and socially responsible investment Karina Litvack. “There has been an enormous ramp-up in the volume of mandates won. I don’t know whether our clients realise the crisis is a manifestation of a breakdown in governance and sustainability, or whether it was something that was happening anyway.”

In the wake of the financial crisis pension funds appear to be taking more seriously their role as responsible owners of companies and custodians of those companies’ governance standards. Institutions want to ensure their managers are being diligent in executing the shareholder rights that have been delegated to them. In the past receiving voting reports might have satisfied them, but this is no longer the case. 

“Historically as long as managers could demonstrate they had governance policies in place clients were happy,” says Watson Wyatt investment consultant Jane Goodland. “Pension funds are now asking more far-reaching questions. They understand there is often a gap between having a policy and effectively implementing it to encourage good governance standards.”

But having good environmental social and governance standards in place is not enough to ensure a successful company. The same thorough standards of research must apply to companies’ management, balance sheet, and product range as these become even more critical to success than in less troubled economic times.

“The green idea isn’t enough on its own,” says Insight Investment’s head of responsible investment Rory Sullivan. “In economic good times one can perhaps be less rigorous in fundamental analysis; in economically tough times fundamental analysis is central to the investment process. When you invest in a company you don’t just look at whether it has good green credentials, but does it have competent management, a robust balance sheet, what is the debt position, what is the cash flow like.” 

The rise in thematic funds has been a feature of the sustainable investment landscape over the last couple of years, with the launch of a whole host of funds devoted to environmental industries, such as clean water, green energy, waste management and so on. These types of funds are by their nature more risky than broader based funds which have a wider universe of investments open to them. In more specialised funds there are no sectors where managers can take cover in a crisis.  

Litvack compares the F&C Climate Change fund with its broader based Stewardship fund which uses positive and negative screening.

“The climate fund is attracting interest even though the particular factors it is exposed to are more volatile than would be the case in a multi-criteria fund, because they are focused on a slice of the market - all those businesses that will benefit from mitigation or adaptation. You have few opportunities to go into defensive stocks the way you would in a sustainable fund.”

There is no clear evidence that sustainable broadly based funds as a whole perform any better or worse than their mainstream counterparts.

“If you look at funds in the global growth sector, the performance over the last year of sustainable funds are not clustered together, they are quite evenly dispersed,” says Goodland. “ESG factors in those funds aren’t necessarily what is driving performance. It’s driven by manager skill.”

Future developments in sustainability investing are likely to involve its application to a wider range of asset classes. At the moment the majority of sustainable funds are equity funds, though many thematic funds are private equity. Sustainable bonds funds have traditionally not featured strongly, but that is already beginning to change. Litvack expects more interest in ethical bond funds.

“Our ethical bond fund has not only performed well it is attracting a lot of fresh money because of people’s concerns about the equity market. You are going to see more people going into fixed income products,” she says.

Sustainable Asset Management’s head of corporate strategy and business development Miklos Vidak also expects more interest in sustainability investing in fixed income, alongside the emergence of more funds devoted to other asset classes and strategies. 

“Sustainability is very biased toward equities but going forward we expect it will be enlarged to other asset classes. Fixed income is a big topic, especially investment in corporate bonds where we expect sustainability will play a huge role in future.”

Another effect of the crisis might be to blur the lines between SRI and non SRI funds by the extension of sustainability criteria to mainstream funds. At HSBC Investments a move is under way to develop its sustainability credentials with more emphasis on applying the UN PRI principles to its investments. 

“If anything the crisis may bring about  a reduction in investment in dedicated SRI and sustainable products and an increase in the sustainable investment practices of the mainstream,” says HSBC Investments’ global head of wholesale, Farley Thomas. “We are certainly changing our approach: we are investing much more focus and energy on complying with the UN principles of responsible investment, training our investment team on sustainability issues and getting them to understand the importance of non financial criteria on investment performance. We are emphasising somewhat less dedicated SRI products.”

Christine Senior is a freelance journalist