The VW scandal has illustrated just how great the benefits of sustainable investing might be, particularly in managing risk, explains Paul Pizzala, Founding Partner of Climate Risk Ltd
Only time will tell exactly how it came to be that Volkswagen made one of the most momentous “clangers” in automobile history. The short story: they fitted their diesel engines with a “defeat device” to reduce test emissions, so that the exhaust fumes appeared to be clean.
It seems to be the case that in a fierce drive to compete for market share, in the US in particular, and to keep up with Toyota that the temptation to cheat and take a short cut was too great. As the reality of their actual diesel engine emissions caught up with their artfully created illusion, it backfired with epic consequences.
For shareholders, stakeholders, employees, managers and suppliers this has a real economic and psychological impact, as well as being a dent to national pride in Germany. It is the complete opposite of “Vorsprung durch Technik”, which translates as “Advancement through Technology” or as the advertising slogan goes in the US “Truth in Engineering”.
The Daily Telegraph quotes (the old BT Pension fund) Hermes’ chief executive, saying that the fallout from this scandal will “revolutionise” investment. Their fund managers had pulled out of VW earlier this year because they feared its corporate governance standards were not up to scratch.
The read across is that environmental, social and corporate governance (ESG) as an investment approach has come of age and, as Hermes shows, it is integral to understanding the qualities of a company and how its management culture will have very real impact on performance. Not only is this is a risk management exercise; it is a way of finding companies that can adapt to the complexities of competition, environment and regulation in positive and profitable ways.
UBS in its recent research paper, “To integrate or exclude” made the point that the majority of stock market capitilisation is to be found in goodwill, reputation and intellectual property – known collectively as intangibles. It takes time and commitment to values, people, products and services to create a great brand. Once the recipe for success is soured it is nigh on impossible to go back.
An emerging trend for company management and fund managers is to engage with issues of environmental, social and corporate governance. It used to be a relatively simple case of screening out “unethical” investments such as tobacco, arms and alcohol where the case was relatively clear-cut between “goods” and “bads”.
In today’s world of global trade, complex supply chains, instant communication and finite resources, including natural capital, life is not so clear cut as the boundaries are blurred. Many stockholders and stakeholders realise that ESG provides a structure to assess the intangible drivers of sustainable wealth. A strong case can be made that this is a crucial way to spot winners and avoid losers in picking investments.
No compromise on performance
Figures from the “Global Sustainable Investment Review 2014” show a jump in sustainably managed assets from 21.5% to 30.2%, in recent years, out of all globally professionally-managed assets, with Europe taking the lead. The question for private clients is whether better values can lead to better performance? Is it possible to have your sustainably responsible cake and eat it, as it were?
In its report “From Stockholder to Stakeholder”, which reviews academic sustainability and outperformance research, the University of Oxford found that there is evidence to show better operational performance and investment performance from companies that use ESG as a framework.
Wealth managers need to understand the risks of a “carbon bubble” and climate change, for instance, and be aware of the relationship between environment, society and governance to navigate these emerging risks and returns.
Translating this into an investment portfolio and meeting client needs and values means choosing a wealth manager with a good investment process and aspirations to be a good corporate citizen too – don’t be afraid to ask a prospective provider about its own ESG record if that is important to you.