With close to two-thirds (62 per cent) of the market committed to investing responsibly, environmental, social and governance investing is no longer a fringe activity, said Sean Cleary, chair of the Institute for Sustainable Finance at Queen University’s Smith School of Business, during the Canadian Investment Review’s 2022 Risk Management Conference.
A combination of factors is driving growth in ESG investing, including regulatory and reputational ethical pressures, he said. “But what’s really driven this acceleration has been customers and other stakeholders . . . — investors [and] employees.”
Citing a 2021 survey by RBC Global Asset Management, Cleary noted 75 per cent of the 800 global institutional investors surveyed were integrating ESG factors into their portfolios. As well, 87 per cent said they believe doing so will mitigate the risk, while 70 per cent believe they can generate alpha through ESG investing. And more importantly, 63 per cent believe factoring in ESG is part of their fiduciary duty.
The integration of ESG into investment decisions is market driven, he said, noting legislation in Canada and the U.S. don’t require institutional investors to factor in ESG considerations. However, in Canada, some important legal decisions suggest boards of directors and pension plan sponsors, in particular, should be considering climate change in their investment decisions.
The more investors integrate ESG factors in their investment decisions, the more those decisions will benefit their beneficiaries because it presents an opportunity to identify big risks, such as climate change, said Cleary. Even though ESG was gaining momentum when the coronavirus pandemic first hit, many people thought, ‘It’s time to batten down the hatches and tighten the ship and forget about these considerations,’ he added, though the opposite happened.
“The returns during the first quarter were actually better for firms with higher ESG ratings, which is consistent with that long-term evidence that it would help you avoid those big risks. In the recovery period, . . . I saw nine or 10 that said, the performance is better.”
Money continued to flow into ESG funds and the number of signatories to the United Nations’ principles for responsible investment increased, he said. “In fact, the performance didn’t suggest that everyone was just going to stop worrying about this for now. . . . The activities, in terms of funds going in, also suggested that investors realize . . . [they] maybe . . . should have seen . . . COVID coming.”
While some of the recommendations after the 2022 severe acute respiratory syndrome outbreak were never put in place for the coronavirus, they should’ve been, noted Cleary, cautioning institutional investors to avoid making the same error by missing the implications of climate change. “We need to start preparing for it . . . [and] trying to get to that 1.5 degree [Celsius target, as set out in the Paris Agreement] or two degree warming scenario. But . . . in the interim, we need to develop some mitigation . . . and adaptations strategies. Because even if we do achieve 1.5 or two degrees, our climate is still getting worse. We’re going to have more flooding and fires and heat waves.”
In terms of the different approaches institutional investors can take, he suggested they use negative exclusionary screening, eliminating sin stocks such as tobacco and guns from their portfolios; ESG integration, where investors integrate these factors into their investment analysis and decision-making processes; and the integration of ESG into their wider portfolio management circles, risk management processes and attribution analyses when evaluating performance.
After ESG integration, the second most prevalent strategy used by Canadian institutional investors is engagement, said Cleary, referring to meetings with clients, filing shareholder proposals and creating proxy voting policies.
It’s also about public policy and how institutional investors engage with public policy-makers, he said, noting collective actions can be an important way for investors to engage on issues like climate action. For instance, Climate Action 100+ started out with investors trying to impact the 100 largest industrial polluters globally and today the organization has grown to 167 companies and 650 signatories with $60 trillion in assets under management.
“When you get that kind of assets, you actually do have a chance to make a change.”