Environmental, social and governance (ESG) investing is becoming increasingly mainstream. In Europe, the volume of assets invested in sustainable investment products is expected to overtake the volume of assets held in conventional funds over the next five years, according to research by PwC. Is this just another fad or is ESG investing here to stay?
I definitely believe that ESG investing is a long-term trend. For investors, the integration of ESG factors into their investment decisions is not only a great way to diversify their portfolios but, crucially, it also enables them to better assess the opportunities and risks that exist for individual companies. In short, adopting an ESG focus is a question of common sense.
For people who may be less familiar with the topic, what is the difference between integrating ESG factors into investment decisions and ethical investing?
That is a good question. There are still a lot of investors who regard ethical investing and ESG integration as the same thing. While it is true that there can be overlaps in terms of final portfolios, the two approaches are fundamentally different. In simple terms, ethical investors are ready to sacrifice part of their returns in order to invest according to specific values and they tend to refrain from investing in firms whose activities are not compatible with those beliefs. The impact they can generate with their investment is therefore limited. ESG investors go one step further by trying to actually motivate companies to change the way they do business by incorporating ESG criteria into their activities and addressing risks in these areas. Through these actions, ESG investors ultimately also seek to improve the risk/return of their investments. The end results might be similar – e.g. a portfolio with lower CO2 emissions – but the approaches taken are quite different.
Public attention is currently focused on the topic of climate change. How is this reflected in the investment process? Do you measure the CO2 emissions of all companies in EFG’s investment universe?
Yes, CO2 emissions are measured for all our direct investments and, when possible, also at portfolio level. Our ESG assessment encompasses emissions as well as the measures taken by companies to reduce their carbon footprint. In recent years, we have significantly reduced our exposures to fossil fuel risks and we have flagged companies with a high risk of having stranded energy assets or excessive coal exposures. The outcome of this process is that with only a few exceptions, the CO2 risk of our funds is significantly below the market average. We also developed a CO2 Scenario Model, which allows analysts to assess the financial impact of CO2 emissions on revenues and operating income under different decarbonization scenarios.
Will the integration of ESG criteria continue to further in the future?
Generally speaking, I think the trend will definitely continue for the foreseeable future. Internally, we are aiming for better integration and improved ESG analysis. Understanding how to better exploit the information we have, obtain new data and improve the granularity of our analysis will be of key importance going forward.
Most investors are focused primarily on performance. Do ESG investments perform better than conventional investments in the long term? And if so, why?
There is academic evidence of a positive correlation with risk/return and there is also evidence that the integration of ESG aspects when investing doesn’t have a negative impact on performance. I think the main advantage is that ESG integration forces us to obtain a much more detailed understanding of the strengths and weaknesses of the companies we invest in. It helps us to understand if the yield/expected return of an investment is aligned with the risks we are taking.
Banks and asset managers have an important role to play in funding the transition to the green economy. Where do you see scope for the finance industry to do more?
I think the finance industry is in much the same position as other industries. It can’t simply stop financing fossil fuels from one day to the next. Equally, it can’t solely finance green projects. In both cases, the impacts of any such decision would be disastrous and create challenges such as unemployment and asset bubbles. At the same time, the finance industry needs to understand that to remain profitable over the long term, it needs to embrace the green revolution. And it is in the industry’s own interests to positively influence the way investee companies perform. The industry has highly diversified portfolios that mirror global capital markets and are inevitably exposed to the growing costs of the environmental and social harm caused by companies. The more these external pressures grow, the lower the return on these assets becomes. It will be a long journey and the entire industry must work hard to create awareness and deliver continuous improvements in the area of ESG.
New EU regulations require asset managers to provide detailed information about the sustainability of their funds. Is this trend set to continue?
Yes, definitely. The suite of European regulations is not yet finalised and in two or three years, the EU will probably start revising it. Other nations such a Switzerland, Hong Kong and Singapore are expected to follow suit and I would not be surprised if the Biden Administration also legislates in this direction.
Profile
Stefano Montobbio, Head of Investment Governance and ESG, is responsible for ESG and investment governance at EFGAM including the integration of ESG criteria in EFG’s funds, mandates and asset allocation processes.
Stefano has over 25 years of experience in banking and finance and has held a variety of investment functions, from fund management to his role as a member of Investment Committees.
Stefano Montobbio has been involved in sustainable finance since 2008 and, while working in former BSI, developed the ESG assessment framework back in 2011. He was a founding member of Swiss Sustainable Finance and he served as Chairman of the private wealth workgroup until 2018.
Further, he has lectured on Sustainable Finance at the ‘Centro Studi Villa Negroni’ since 2015 and he serves as Chairman of the Board at cenpro foundation.