Interest in environmental, social and corporate governance investing (ESG) is growing very rapidly in the market. Clients and prospective clients who in the past may have shown less interest in the topic have become more engaged on these issues from a number of different perspectives. Some asset owners see their investments as having dual objectives: maximising (risk-adjusted) financial returns while also achieving ‘societal gain’ via better governance, environmental impact and similar factors, for instance. At the other end of the spectrum are investors who do not believe that ESG investing will definitely enhance returns, or that it should be used to achieve specific societal goals, but who do wish to avoid investment in certain sectors or stocks because of ESG-related risks, including reputational risk. In-between those two ends of the spectrum are many other shades of opinion, of course.
At Kleinwort Benson Investors, it certainly seems to us that, wherever investors were on the spectrum one or two years ago, they have been moving towards the more ‘progressive’ end of the spectrum, to a greater or lesser extent.
A growing market
With that in mind we began a programme of enhancements to our ESG offerings, internal procedures and our investment processes. We do not, incidentally, believe that this is a static process. The only certain thing that we know about ESG investing is that it will continue to evolve and change in the years ahead, and probably very quickly. We continue to enhance our ESG offering in an effort to match our client needs. For quite some time we have excluded, as a matter of company policy, investments in companies that manufacture landmines or cluster munitions. We have not changed that policy.
The only certain thing that we know about ESG investing is that it will continue to evolve and change in the years ahead, and probably very quickly
One key step in this enhancement programme of our products was to review our external service providers. Following extensive review, we appointed MSCI ESG Research as our primary provider of ESG research and ratings, and continue to use Institutional Shareholders Services (ISS) as our proxy voting research partner. The case for outsourcing such a specialised and labour intensive function is strong and we felt that internal ESG research should be completely independent, and not be influenced by the fact that we might hold the stock. MSCI ESG Research is of course one of the largest and most credible ESG research and ratings providers, and we believe that they are the right service provider for us to work with as we significantly expand our ESG activity.
We have also adopted a more comprehensive and nuanced set of negative screens that are used for the ESG-specific versions of our global equity strategies. These negative screens are based, in part on the socially responsible investing guidelines of the United States Conference of Catholic Bishops and exclude investments in certain controversial sectors such as tobacco, adult entertainment, coal and others.
To be clear, these negative screens are only used in the ESG versions of our global equity strategies. This gives investors in our global equity strategies the option of applying those screens, or not, depending on which version of our products they invest in. We also continue to offer bespoke custom screening as directed by specific clients.
We have recently launched a new emerging markets equity ESG strategy. This strategy employs our core investment process used by all our global equity strategies, but in addition: applies negative screening to exclude investments in certain controversial sectors, as weapons and coal; excludes stocks, regardless of sector, with the lowest ESG rating as determined by MSCI ESG Research; and positively integrates ESG factors into the investment process by creating a portfolio which aims to have an overall ESG rating substantially higher than the benchmark.
This strategy was launched in the fourth quarter of 2014 and is already attracting much interest given its innovative features. We also have an existing global and eurozone version of the fund.
Within our environmental strategies we have significantly enhanced the ESG integration within our investment process (essentially formalising an existing less formal process). We now explicitly use ESG ‘scores’ for two of the four pillars which comprise our key proprietary valuation model. We believe that companies whose products and services enhance social or environmental goals deserve a higher valuation. Such companies are more likely to have long, durable, sustainable business models.