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Sustainability investing to raise financial performance in the long run

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This is a sponsored article from Robeco.

“Social responsibility”, “green bonds”, “community investing”, “corporate engagement”, “ethical investing” – sustainability investing and its bucket of relevant terminology are among the hottest buzzwords in the investment community.

The fervour is clear as more than 230 constituents of the S&P 500 — almost half the index — were discussing core environmental and social issues in 2017, according to transcripts of quarterly earnings calls.1

But with its esoteric roots reaching back to the green crusades of the sixties, is sustainability investing just hype, or is there now a compelling investment case for it?

Statistics point to the latter, indicating that sustainability investing is not only here to stay, but is also catching on fast in mainstream investing. The most targeted sustainable investment strategy is exclusionary screening, with US$15 trillion of assets in such strategies at the close of 2016, according to Robeco and RobecoSAM. This was followed by integrating environmental, social and governance (ESG) into mainstream strategies, with US$10.4 trillion of assets, and corporate engagement, with US$8.4 trillion.

In terms of geographies, Asia Pacific has been seeing a heavy focus on improving corporate governance, with Japan ranking as the region’s fastest-growing jurisdiction in sustainability investing between 2014 and 2016, followed by Australia and New Zealand, according to “The Big Book of SI” — a comprehensive sustainability report published by Robeco.

No stranger to the approach, Robeco began adopting sustainability investing in the mid-nineties, strategically integrating it with their core asset management business in the mid-2000s with the acquisition of Sustainable Asset Management — now RobecoSAM.

“The topic of sustainability arises within minutes of talking with clients,” says Gilbert Van Hassel, CEO of Robeco.

“I believe that we have reached an inflection point. It is already clear that taking a sustainable approach does not detract from performance. We believe that using financially material ESG information leads to better-informed investment decisions and benefits society.”

Indeed, there is a growing sense of awareness and even urgency towards the value and indispensability of sustainability investing, as investors find themselves facing the investment risks and downsides concomitant with the benefits and upsides of accelerated economic growth in both emerging and developed markets.

This makes for an investment landscape that’s vastly altered from 20 years ago.

These risks are manifesting in the form of an increasingly uncertain regulatory and policy climate, intensifying environmental awareness and motivating social activism which bear the potential to alter consumer and investor behaviour, erode asset and investment value, raise compliance or remedial costs, and wreak reputational damage.

As world leaders move towards achieving the United Nations’ 17 Sustainable Development Goals (SDGs) by 2030, such risks have come into alignment with global awareness of the damaging consequences of unchecked economic progress and advancement, most notably in climate change, pollution, health epidemics, and resource scarcity.

It has become clear that while prioritising economic growth above environmental and socioeconomic concerns may yield higher financial returns in the short term, the longer-term prospects for such a strategy may hold a dimmer promise.

Forward-looking risk mitigation
To avoid being blindsided by the myriad of risks associated with environmental and social backlash, the best approach is to proactively engage in sustainability investing — that is to integrate ESG principles into core investment strategies.

As such, portfolio managers are increasingly looking to create more sustainable portfolios to meet the demands of sponsors, participants, stakeholders, and regulators alike.

But how do investors go about taking sustainability into account in a tangible and measurable way?

As sustainable strategies widen from an environmental focus to encompass a broad range of current social issues — ranging from human rights to gender equality — it’s no wonder investors often feel hard-pressed to identify a clear-cut approach.

Using three megatrends to illustrate sustainability approaches
Every sector has its own challenges, be they sustainable supply chains and the social risks of sugar consumption in the food industry, sensible pricing models and business ethics in healthcare, or risk culture and product stewardship in the financial sector. There are also sustainability issues to consider from a country perspective: the strength of institutions, investment in education, and access to natural resources to name but a few. Robeco has identified three important themes that specialists across the globe believe to be among the most important environmental (climate change), social (inequality), and governance (cybersecurity) matters of our time. Further, it has considered these challenges in its different sustainability approaches — such as exclusion, ESG integration, active ownership, sustainability thematic strategies, impact strategies, and sustainable strategies.

Megatrend 1: Climate Change
It is important for investors to assess the impact of climate change on asset class return expectations. The most significant physical impacts of climate change will be seen in the second half of this century, but the consequences for forward-looking asset markets may become apparent much sooner. When expectations for climate change are adjusted, the markets and asset prices will reflect these developments, possibly sooner than the physical changes of global warming make themselves felt.

The macroeconomic impact of climate change will be heavily influenced by environmental policies. It is impossible to calculate this impact with any degree of certainty, but based on a report by the University of Cambridge Institute for Sustainability Leadership, Robeco believes a plausible scenario is a world in which past trends essentially continue, with temperatures rising to 2.0-2.5°C above pre-industrial levels by 2100. The world would succeed in slowly reducing its dependence on fossil fuel, but it would take longer for the positive benefits of the new low-carbon economy to make a noticeable impact.

Based on this scenario, the worst-performing sector in developed markets would be real estate, followed by basic materials, construction, and industrial manufacturing. The best-performing sectors would be transport, agriculture, and consumer retail. Investment risks can be mitigated by switching out of the worst-performing sectors and into the better performers.

The Cambridge study also reveals differences between countries in terms of the vulnerability of their economic fundamentals and how they respond to shocks. Brazilian stocks, for example, are reasonably resilient whereas the Chinese market fairs less
well. The study concludes that in the end, slightly less than half of the returns impacted by climate change can be hedged through cross-industry and regional diversification.

As global warming is tackled in the coming decades, investors will need to know what to invest in — and what to avoid. This ranges from multi-billion-dollar projects harnessing renewable energy to new business models in traditional industries such as car manufacturing, utilities, and energy.

Tackling climate change
Robeco recognises the scientific consensus that human activities are responsible for increasing the amount of greenhouse gas in the earth’s atmosphere, thus causing climate change.

There are several ways investors can address climate change:

  1. By integrating information on carbon strategies of companies into the investment process
  2. By using active ownership to effect change
  3. By decarbonising portfolios
  4. By divesting from carbon-intensive thermal coal
  5. By investing in clean energy and energy efficiency strategies

Megatrend 2: Rising Inequality
Rising inequality has fuelled discussions on its economic, political and social implications. To date, however, the debate has been controversial and the economic literature inconclusive. Inequality can affect economic growth through different channels, potentially promoting growth as it provides sufficient incentives to accumulate capital, increase productivity and investment, and reward innovation and entrepreneurship. On the other hand, it causes poverty, contributes to a sub-optimal allocation of human resources (low-income groups have limited access to education and health care), reduces social mobility, erodes social cohesion, leads to the concentration of political power, and boosts populist policies. All of these have a dampening effect on investment and productivity, undermine economic growth, and have the potential to cause macroeconomic and financial disruption.2

There is considerable evidence that the potential for social and political unrest is higher in countries with relatively higher levels of inequality, and these countries are also considered to have inferior sovereign credit quality. Meanwhile, lower levels of inequality (as illustrated by the Gini coefficient) correspond with lower risk premiums and potential for unrest (as represented by sovereign CDS spreads and the Fund for Peace’s Fragile States Index, respectively), even though inequality is of course not the only explanatory factor.

Investors would be well advised to keep a close eye on the developments in inequality, which could result in subdued economic prospects, a higher level of social uncertainty, more volatile — and lower — investment returns, and a reduced number of attractive investment opportunities. A structured approach to incorporating country-specific ESG information in investment processes could help inform investment decisions.

Addressing the dilemma of rising inequality
Robeco incorporates intra-country inequality into its country assessments for emerging equity and (emerging) fixed income government bonds investment processes. In its impact funds, it actively invests in companies that have a positive contribution to the SDGs — including those committed to reducing inequality. Meanwhile, Robeco’s Fintech fund invests in companies that directly reduce inequality by providing access to the financial markets to groups that financial institutions previously would not serve.

Megatrend 3: Cybersecurity
Cybersecurity spending is a fast-growing cost for many businesses, but for the moment it is unlikely to impact profit margins too severely. At less than 5% of total IT spending for most companies, the cost of cybersecurity can still be absorbed relatively easily. What is less predictable, and potentially much more devastating, is the cost associated with a ‘successful’ breach or data privacy issues, which can be reflected in sharp share price drops, as was seen after the Equifax breach and the Facebook/Cambridge Analytica scandal in 2018. It is therefore in investors’ interests to urge companies to enhance their cybersecurity measures and encourage them to improve not just their technology but also their behaviours.

The bright side of all this is that the rapid growth in cybersecurity spending is providing ample opportunities for solution providers to start successful businesses. The current marketplace is a mix of established, usually mature cybersecurity vendors that made their mark in older security products such as anti-virus software and firewalls, and a new breed of companies that are rolling out next-generation cybersecurity products and services. The market’s quick growth is providing a welcome tailwind for everyone involved, but competition is fierce and success is not guaranteed, so investors need to take a highly active approach in this area.

Major opportunities in cybersecurity
After starting an engagement theme related to data privacy in 2016, Robeco’s engagement team embarked on a three-year engagement focused exclusively on cybersecurity in 2018. Robeco’s engagement specialists work in close collaboration with portfolio managers to address the risks stemming from the world’s increasing dependence on computers and digital data. In its thematic funds, Robeco sees the increasing need for cybersecurity solutions as a major investment opportunity.

Sustainability and succession: Taking care of the next generation
At the end of the day, the clarion call for sustainable investing has sounded, and it is up to shrewd investors to rise to the occasion, actively engage in the conversation, and chart a course of action that is right for their investment goals.

In the short run, sustainability investing alleviates risks both latent and manifest, separating prescient investment from the rest. In the long run, it engages in meeting the needs of the present generation without compromising those of generations to come, according to Robeco, which manages EUR 100 billion of integrated sustainability investing in equity, fixed income, and private equity.

Encapsulating and fusing the very philosophies of innovative value creation and succession planning, sustainability investing builds wealth and well-being for this generation and passes on a remarkable legacy to the next.

Founded on a unique sustainability culture that has evolved over the last 20 years, Robeco and RobecoSAM’s joint sustainability strategy is based on extensive in-house expertise in research, analytics, and investments. The firm offers a truly integrated investment approach across the asset classes stemming from the interaction between researchers, financial analysts and engagement specialists, paired with the ability to innovate quickly and offer clients bespoke solutions as sustainable investing evolves.

Click here to download Robeco’s Big Book of SI.

1 Goldman Sachs, “A Revolution Rising – From low chatter to loud roar”, 2018.
2 Grigoli, Francesco & Robles, Adrian: inequality Overhang, IMF Working Paper 17/76, 2017

Important information
Issued by Robeco Hong Kong Limited, licensed and regulated by Securities and Futures Commission of Hong Kong. The contents of this document have not been reviewed by the Securities and Futures Commission Hong Kong. Investment involves risks. This information does not constitute an offer to sell, a solicitation of an offer to buy, or a recommendation for any security.

This is a sponsored article from Robeco.

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