Friday 29 Mar 2024
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This article first appeared in Personal Wealth, The Edge Malaysia Weekly on September 11, 2017 - September 17, 2017

Investors looking to adopt responsible investment practices are not limited to financial products. They can also make adjustments to their decision-making processes or mandates by incorporating sustainable strategies into their investments, according to Martin Skancke (picture), chair of the Principles for Responsible Investment’s (PRI) advisory council.

“There are many ways of doing this,” he says on the sidelines of a conference organised by PRI in collaboration with Bursa Malaysia and the Securities Commission Malaysia.

“It is important to distinguish between asset owners and investment managers. Asset owners, who use external investment bankers for example, have to choose the right contracts that reflect the right incentives so that they reflect the long-term orientation of the asset owners. It is much more about how you think about the environmental, social and governance (ESG) issues in terms of asset allocation and engagement with investment managers.”

PRI engages with global policymakers and provides the necessary tools for responsible investments. It also encourages investors to use responsible investments to enhance returns and better manage risks.

There are many qualitative and quantitative processes that investors can utilise, says Skancke. For example, some asset owners prefer the positive screening approach, which is the process of actively searching for best-in-class companies to invest in. This approach reflect the values of the investors, be it leadership, policies, environmental practices or human rights.

“When you use this approach, your sector allocation is unchanged. But you are choosing to invest in the best companies in each sector,” says Skancke.

“Some are more focused on taking out the worst performers — what we refer to as the negative screening process, where companies that score very poorly are omitted from the investment decisions. So, rather than investing solely in the top 10%, you take out the bottom 10%.”

He points out that responsible investing can be applied by all investors, including purely passive index investors. “If you are an index investor, you will not make changes to your asset allocation. But you can still be a responsible investor through your engagement policies, for instance.

“I also think there is a misconception that responsible investing has to do primarily with what you do not invest in and that responsible investing is about taking away massive investment dollars. But responsible investments are much more about a systematic approach to addressing ESG risk factors and basing your investment decisions on the much broader information available.”

Faith-based and value-based investing are other types of approaches that investors can consider. Skancke says the concept of legitimacy plays a very important role in these two approaches.

“There are some sources of profit that are not legitimate, which is one of the basics tenets of Islamic finance. But this is not just in Islam. There have been other religions and communities in other parts of the world that practise faith-based investing,” he adds.

He points out that the Quakers — a Christian movement that arose in the 17th century — denounced slavery in the American colonies and Europe and refused to invest in the slave trade. “This is a tradition that goes back centuries.”

Skancke, who was head of monetary policy and public finances at Norway’s Ministry of Finance prior to joining PRI, says the Scandinavian country — which had ratified international conventions that banned the use of landmines — has taken additional steps to avoid investing in companies that produce landmines as well.

“It would be wrong for us to profit from the production of something that we are against. So, we have excluded landmines from our investments,” he says.

“It is not because we thought about it from an economic or sustainability assessment point of view, but from our values. Unfortunately, some people may argue that the business model of someone producing weapons may be sustainable in a purely business sense because there will always be a demand for it.

“So, that decision was entirely value-based. It is just saying, ‘No, we don’t think this is an appropriate way for us to earn returns.’ It is based on an assessment of what a legitimate source of profit is.

“Tobacco, which we have also excluded, is another example. There is nothing inherently unsustainable about the business model of tobacco companies. It is just that we don’t think it is an appropriate way for a publicly owned fund to earn money.

“What is seen as legitimate sources of profit will vary from country to country. But the whole concept that there are some lines you should not overstep is an important historical tradition.”

Active management strategies where fund managers choose not to invest in a company or product based on an assessment of sustainability are another option, says Skancke. “An investor may divest from the coal sector, for example, not because he thinks it is illegitimate — because coal is still an important source of energy and it is also not unethical — but is just saying that as an investor, he does not really believe in the future of this industry.

“That is one way of incorporating the view of sustainability into an investment decision where I ask myself whether I really think the environmental risks that come with coal is sufficiently reflected in the market price today. So, there are many ways to get to that end result. Each investor has to find a palatable approach.”

Sustainable investments surged to US$2.6 trillion last year as more investors found that funds that meet ESG goals perform as well as traditional funds. According to a biennial report by Washington-based US SIF Foundation — the Forum for Sustainable and Responsible Investment — the sustainable, responsible and impact-investing category has garnered US$8.72 trillion worth of investments. This represents about one-fifth of all managed investments globally.

The UN’s Sustainable Development Goals also play a role in the increasing adoption of responsible investing, says Skancke. The SDGs, which were established in 2015, define sustainable development priorities — comprising 17 aspirational goals and 169 targets — to be achieved by 2030.

While a majority of the investments are driven by institutional investors in developed regions, Asia is catching up fast, says Skancke. “In Asia, there has been a lot of focus on governance issues and that is reflected in the strong growth of stewardship goals. So, I think it is different from other regions where there are concerns about other issues.

“PRI membership has grown faster in Asia than all the other regions over the past year. So, Asia may have started at a slower pace, but it has posted a higher percentage of growth.”

Khazanah Nasional Bhd, Malaysia’s strategic investment fund, is among the 101 PRI signatories in Asia.

Skancke says the demand for responsible investments is increasingly driven by retail investors. “I asked one of the new signatories in the US, which is a pretty a large institution, why it signed on to PRI. It had two reasons. One is that its clients wanted ESG risk-adjusted products and needed to understand how to invest in them. Second, it was going around to the best universities in the US trying to recruit fresh graduates and the students said they would only work for the institution if it had an active view on responsible investing. So, I think it is driven by consumer demand in many regions.

“Morningstar has started to rate funds on ESG. It does that not only for dedicated funds but for all types of funds. I think that empowers retail investors a lot because now they have a tool to see how their funds are scored on ESG.”

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