While there’s a lot of noise and confusion around environmental, social and governance factors, it comes down to delivering value for investors in terms of better risk-adjusted returns, said Aaron White, CIBC Asset Management Inc.’s vice-president of sustainable investments, during a session at Benefits Canada‘s 2023 DC Plan Summit.
Part of the confusion around the topic, he noted, stems from the backlash in certain U.S. jurisdictions against ESG integration, which he clarified as being focused on the financial materiality of non-financial considerations. In addition, inconsistent regulations and the lack of a formalized taxonomy to define ESG have also made the topic difficult to understand for many institutional investors.
“When we break out the ‘E,’ the ‘S’ and the ‘G,’ . . . these are not present on a company’s financial statements, but can have material financial implications to either the share price or, ultimately, to the tailwinds for the success of the company over the long, medium or even short term.”
These non-financial factors can materialize within a company and create financial risk factors for investors, said White, citing several examples, including Equifax Inc., which experienced a major data breach in 2017 and a subsequent decline in share price.
“As an investor, you should consider data and privacy policies as an extremely important element of the risk factors of investing in Equifax. . . . This has reverberating impacts as an investor in terms of volatility, in terms of your overarching absolute return and is based solely on an ESG risk factor that materialized within that company.”
Describing climate change as “the elephant in the room” as it relates to ESG investments, White noted that, across various climate change scenarios, a significant amount of net present value risk exists, potentially one of the biggest risks investors will face from a systemic market exposure perspective in the next 15 to 25 years.
“The key takeaway here is to not adjust your asset mix. Think about your strategic asset allocation and change the way you invest — but ultimately, this is a key factor as it relates to thinking about how your manager is delivering on their ESG expectations, their risk management process and, ultimately, their portfolio construction process.
“You want to make sure that they have those appropriate climate risk policies and processes in place, that they have the risk analytics and measures in place, to understand what type of exposure they have relative to these benchmark risks.”
For defined contribution pension plans, ESG is a particularly important consideration due to member demographics, said White. “DC plans significantly skew to a younger age demographic. Those demographics are stating that they care about these considerations as it relates to their portfolios.”
Plan sponsors also have an opportunity to engage members in conversation about ESG, he said, citing a recent survey by CIBC that found ESG was among the factors retail investors of all ages wanted to discuss with their financial institution. However, just 50 per cent of these respondents said they’ve actually engaged in conversations on the topic.
“This is an area of interest for them and an opportunity for you to directly engage on an issue that they want to talk to you about. . . . [Plan member] values are an increasingly important component of how investors select their investment mandate and their investment manager. And [these members] may have investments outside of your DC plan where they’ve integrated their values into their portfolios, which means that they may be looking to you for how they can replicate that same thing inside the context of the plan.”
Read more coverage of the 2023 DC Plan Summit.