An effective sustainable investment approach will require an understanding of the challenges that asset managers are facing today.
To help flesh out these challenges, MFS® and Eurasia Group convened a series of discussions with asset managers, asset owners and academics. We discuss below many of the ideas shared during these exchanges.
What is your sustainable investing goal?
Despite the increasing focus on sustainability-related issues, there is still a lack of clarity about what asset owners want to achieve. Goals include meeting public commitments, a desire to have a positive impact and incorporating material financial ESG-related impacts that are often not accounted for in general due diligence.
Not all clients share the same goals, leaving asset managers to balance a diverse set of objectives, including some that are not clearly articulated. Financial returns may still dominate, but it is not clear that end clients, often represented by trustees, have understood the potential tradeoffs involved when constraining investment criteria are applied. While clients may want a more ‘sustainable' portfolio, very few are willing to give up returns to achieve this.
In addition, investor reputation, media coverage (and the obfuscation caused by political messaging) can hijack original intentions, causing investors to exclude a country or company, even if others in the portfolio have less favourable overall ESG profiles.
Deconstructing the exclusionary and static approach
Sustainable investment was built on exclusion approaches developed over decades and in some instances codified into laws such as the EU taxonomy. Asset managers, financial institutions and companies have developed many of their sustainable investment strategies based on exclusionary approaches. In addition, the ease of use and transparency of an exclusion approach makes it attractive to asset owners. Regardless, the issues with the exclusionary approach necessitate a change.
Creating a sustainable investment system that can be used across asset classes
The ex-ante exclusion approach is particularly problematic when applied in a sovereign context. This is true especially for those countries that sit in the middle of the pack in ESG terms — it is easy to exclude the worst governance and democracy performers, but harder to evaluate more subtle or conflicting issues. Ex-ante exclusion lists commonly used for other fixed income products will constrain analysts' ability to evaluate more complex situations.
For example, the Russia-Ukraine conflict and the related energy security concerns pose a dilemma for governments and for sustainable investors alike. European governments have committed to the net zero transition, expressing fully developed plans investors can use to judge for compliance with Paris targets, and eventually for progress on the transition. Most European Union countries are likely to meet an inclusion standard, even if there is clear differentiation across countries. But energy security considerations put a spanner in the works: although high energy prices provide a strong incentive for reducing energy usage, energy security considerations mean the short-term emphasis is on creating a stronger, reliable flow of energy. That in turn may lead to rapid construction of LNG facilities, re-firing of coal plants, extension of the life of nuclear power stations and so on. The impact is hugely differentiated across countries, depending as much on geography and the existing infrastructure as on current policy and future intentions. The shock has uneven impact across countries, sectors and households. It is, in other words, deeply political.
The immediate political imperative of energy security clearly dominates energy transition concerns. But what about in the future? How do we assess governments that prioritize energy security over the energy transition?
This post is funded by MFS