Over $30 trillion is now invested according to environmental, social and governance (ESG) criteria – a figure that rose by a third in 2016-18 alone. Lavanya Chari, Head of Global Products and Solutions at Deutsche Bank Wealth Management, and Christian Nolting, Global Chief Investment Officer, discuss why ESG investing is fast becoming the ‘new normal’ for global finance.
The term ‘ESG investing’ has been with us for 15 years now, but it seems to have reached a tipping point in 2019. Why do you think that is?
Lavanya Chari: Essentially, the world has woken up to the realization that investing has a critical role to play in addressing the biggest challenges faced by society. It is environmental issues – the ‘E’ in ESG – that are receiving the most media coverage for obvious reasons, but there has also been a shift in consciousness about the S and G factors too. More and more investors are becoming determined to see their values reflected across the whole spectrum of their investing activity.
Christian Nolting: Investors are also realizing that ESG investing does not have to mean sacrificing performance, because when you select investments based on how well they are able to reduce environmental and regulatory risks, you reduce potential financial risks too. The flow of capital into ESG investments has accelerated as a result – in the year to March 2019, the value of assets benchmarked to MSCI ESG Indexes, for example, rose by 33% to reach over USD 149 billion. So ESG investing has definitely entered the mainstream.
LC: I come from India where it is not difficult to find evidence of the harm that bad governance can cause, and I think most investors understand the connection between good corporate governance and good financial performance. They also understand that problems such as climate change create opportunities in particular sectors such as renewable energy. What’s more interesting is that clients are now increasingly looking for investments that promote social progress. They recognize that diversity is good for business, for example, and are becoming more insistent about issues such as female representation on company boards.
What are the most common questions that clients are asking in relation to ESG investing? And how do you answer them?
CN: They tend to ask first about the financial return, because they worry that ESG investing may mean lower profitability. But when you construct a portfolio according to ESG criteria, you are really just being more selective. We can offer a lot of reassurance just by pointing to the large and growing body of ESG investing research, and to the track record of our own ESG mandates dating back 10 years.
LC: Right now, most of our clients are looking to absorb as much knowledge as possible. Some are sophisticated but have yet to find an approach to ESG investing that is suitable for their individual needs. Others are concerned about a particular problem, such as climate change, and want to learn more about the particular opportunities this presents, such as renewable energy investments or green bonds. Our first job is to clarify their needs and priorities. Then we can help them identify the most appropriate ESG investing solutions from the large variety available.
People have very different ideas about what is right and wrong for society. Is ESG investing flexible enough to accommodate these differences?
CN: The short answer is yes: in its simplest form, ESG investing enables you to exclude things from your portfolio that you believe to be bad for the world and include things that you believe to be good for the world. But to change the world you need a consensus on what positive impact looks like, and various organizations have therefore developed lists of ESG factors on which to compare and contrast different investments. What is critical is that these criteria are clear and transparent, so that investors can understand how ESG investment selections are made.
LC: To compare how ESG-friendly an investment is relative to another, you need a consistent methodology. That’s why independent ratings are at the core of our offering. We need to recognize that the world still needs some industries in which it is very difficult to achieve a high ESG rating, but with the right information investors can use high-scoring investments to ‘offset’ the negative impact of low-scoring investments in their portfolio.
There seems to be a lot of debate about what ESG investing is and how it works. What is being done to help investors make sense of it all?
LC: The whole industry is working towards a consistent set of definitions. We’re not there yet, but we’re working with industry forums to create as much transparency as possible. At the same time, we are holding round-tables and other events around the world to help clients understand the jargon and the nuances of the field, as well as the latest opportunities. We are definitely seeing a growing consciousness about the importance of ESG investing and what it can do for the individual investor, as well as for society.
CN: There are a range of initiatives in progress around the world. In Europe, for example, the European Commission’s Action Plan for Sustainable Finance is the most important initiative for the creation of common and transparent ESG standards, while in China the government is promoting the development of regulations for green bonds – a market expected to grow exponentially over the coming years. In the meantime, artificial intelligence systems are being used to carry out ESG analysis and plug information gaps.
Many young people today are sceptical that the capitalist system can produce positive social change. Do you think they will embrace ESG investing?
CN: Young people in the Developed World are more globalized than their parents and grandparents, and the work of earlier generations – to maintain peace after the Second World War and to create a social safety net – has given them a stable platform from which to build progress on issues that affect us all, such as Climate Change. So, yes, we believe they will embrace ESG investing and push it further into the investment mainstream for decades to come. Ethical beliefs are becoming a factor that sits firmly alongside financial return as a motive that drives investors, and this represents a fundamental change – a new kind of enlightenment, in fact.
LC: Awareness of ESG issues among the younger generation has certainly increased in leaps and bounds. My seven-year-old daughter recently told me that she didn’t want to use plastic straws at a restaurant because she’d been learning at school about the environmental harm they can cause. Things like this naturally make me feel that I need to do more for future generations, and I know our clients feel the same way – leaving a positive legacy is very important to them, and will therefore be another driver in the growth of ESG investing in the coming years.
CN: Ultimately the power of ESG investing is that it represents a realistic way to build a better world for everyone, by aligning financial rewards with agreed standards for progress. If we try to do everything at once, we are guaranteed to fail, but if we create a system in which countless incremental improvements become possible then, over the long term, we can produce positive impact on a global scale.