Going Mainstream with ESG

06 Jul 2015

OVERVIEW

As access to information increases, investors have wider opportunity sets to choose from, and the tools to manage risk are becoming ever more sophisticated. Investors are becoming more demanding – and more knowledgeable – in scrutinising their holdings. And the investment world is all the better for it.

One key change has come with ESG practices, an investment philosophy that looks to add an “ethical” dimension to the investment process by analysing companies’ environmental, social and governance practices. In contrast with earlier incarnations of ethical investment, ESG eschews a proscriptive approach in  favour of enriching a fund manager’s tool kit for finding the best investments. So besides helping avoid questionable companies or prompting others to change their ways, ESG should also highlight the star performers in governance and social practices. This, in turn, should guide fund managers towards companies that are exemplars in strong, sustainable and profitable management.

Or so the theory goes. But what do fund managers themselves have to say on ESG? To find out, we talked to Dirk Molenaar and Edwin Simon, two managers at BNP Paribas Investment Partners whose experiences show just how developed and diverse ESG has become. This is the second of a two-part series on ESG and what ESG investment means in practice. To access the first part, an interview with Jacky Prudhomme, the head of ESG integration at BNP Paribas Investment Partners, click here (http://institutional.bnpparibas-ip.com/the-ins-and-outs-of-esg-investing/).

WHICH ASSET CLASS OR INVESTMENT CAPABILITIES DO YOU MANAGE?

Dirk: I am a portfolio manager for the Global Listed Real Estate team, with a particular focus on North America. I am also the ESG correspondent for the team.

Edwin: I am a portfolio manager with the Netherlands-based global equities team. I work out of the Amsterdam office and the team is managed by Sander Zondag.

EXPLAIN HOW YOU HAVE IMPLEMENTED ESG CRITERIA WITHIN YOUR INVESTMENT PROCESS? WHEN DID YOU FIRST BEGIN IMPLEMENTING ESG CRITERIA?

Dirk: We include ESG criteria in our bottom-up part of the process within a broader assessment of a company’s quality and risk. As part of our investment process, we have for each company in our investment universe a quality and risk score. In the real estate sector, environmental practices might relate to green building, social could be related to the percentage of men and women on boards, and governance could focus on, for instance, whether a board is non-staggered [ie, an annual election of all directors] or staggered, or whether it contains independent directors Corporate governance is very important, as some companies can use ‘poison pills’ or other structures to avoid takeovers. We don’t see these as the best option because, in our view, it should always be up to the shareholders to decide. From the social angle, if we notice that the company has certain issues regarding working conditions, working opportunities and so on, we analyse that and try to raise it as a topic of conversation. As you can imagine, health and safety is a particularly big issue in construction, but there’s also a bit of a trend emerging called wellbeing, which relates to
such factors as working conditions and the impact on productivity, equal opportunities, and the social responsibility of the company.

Edwin: For each company we add to our portfolio we write an investment case containing a separate ESG chapter that includes an ESG score. This score is based on comprehensive internal and external research and provides us with insights into how the company is ranked within its industry, based on ESG criteria. We also look at disclosure around ESG factors on the company’s website and annual reports, along with the ESG policies and standards the company adheres to. Finally, we also look at our main ESG topics, which frequently differ across industries. In the mining industry, for example, toxic waste, riverine tailings and CO2 emissions are important, while in the financial sector it is more about policies to avoid bribery, money laundering and litigation risks.

WHAT PERFORMANCE RESULTS HAVE YOU SEEN AS AN OUTCOME OF THE IMPLEMENTATION OF ESG CRITERIA?

Edwin: It’s difficult to quantify the impact of implementing ESG criteria into the investment process as many factors influence the performance on a portfolio level. However, we can say that we truly believe ESG factors are part of the investment case. It says something about leadership and vision when a company adheres to high standards regarding ESG. This can contribute to the performance of a company. In addition, from a risk perspective, it makes you sleep better at night when you know the company is doing its utmost to avoid environmental, social or governance scandals.

Dirk: For now, it’s mainly qualitative: we give companies a score based on their ESG performance, but it’s not yet directly linked to financial performance or total returns.  It’s something that needs to develop over the next few years. It’s a broader challenge among companies implementing ESG, and I’m not aware of other investment sectors that are already quantifying its effects. Our colleagues here are embracing it and it may take a greater weight in future. We want to be ahead of the game and see what’s going on in the market and act on that.

ARE THERE OTHER NON-PERFORMANCE BENEFITS  YOU HAVE SEEN AS A RESULT OF IMPLEMENTING ESG CRITERIA?

Edwin: For BNP Paribas Investment Partners as whole, I have noticed that you can have a positive impact on the ESG policies of companies when you proactively discuss this with them. Especially when you hold the shares of the company, management is very willing to listen to you and carefully consider your proposals. At this moment, the centralised ESG team of BNP Paribas Investment Partners based in Paris is very involved in this, but I think portfolio managers can play a bigger role. In the end, we should actively cooperate together in order to make a difference.

Dirk: We are members of several organisations – for example, GRESB [the Global Real Estate Sustainability Benchmark] – that have developed a global real estate sustainability benchmark. For us as a team, we want to make sure we do what we say we will do. So if we say we want to make ESG a more central part of our investment process for the global listed real estate capability, then that has to be reflected in the actions of our investment team. Working through organisations like GRESB, we can identify companies which perform well by these criteria and win awards, thereby showing to the investment community there are leaders in this space and that we are serious about ESG.

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