Sustainable investing has gained momentum in the investment industry as ESG (environmental, social and governance) companies mostly outperformed their broader index counterparts during the first quarter of 2020—a period of considerable volatility. While several strategies fall under the heading of sustainable investing, the term is mainly associated with ESG integration, which incorporates ESG information into financial analysis. A virtual panel discussion held on May 27, 2020, moderated by Dr. Sean Cleary, CFA (executive director, Institute for Sustainable Finance),  saw experts discuss the ESG investment framework and how COVID-19 has affected sustainable investing. The panelists included Deborah Ng, CFA (director, strategy & risk and head of responsible investing, Ontario Teachers’ Pension Plan), Lindsay Patrick, CFA (managing director and head of the Sustainable Finance Group, RBC Capital Markets), and Martin Grosskopf (vice-president and portfolio manager of sustainable investing, AGF Investments).

Approaches to sustainable investing

Each panelist provided insights on how their organization approach sustainable investing. The discussion, which showcased best practices from the Ontario Teachers’ Pension Plan (OTPP), RBC Capital Markets, and AGF Investments, included the following common themes:

Identifying materiality: Material ESG factors can be identified by understanding key drivers of a company’s profitability. It is then important to assess the company’s management structure and day-to-day processes to determine whether it is effectively handling the associated risks.

Risk-return trade-off: ESG can be used as a tool to uncover opportunities; but, like other investments, the risk-return trade-off should also be considered. Martin Grosskopf shared one example of an early position in a company AGF looked at that held a leadership position in tech. The decision posed a challenge because the company showed favourable performance attribution, but also had governance issues. The situation subsequently became a learning opportunity, when AGF exited its position and opted to invest in companies that had similar skills but were viewed more favourably from a management perspective.

Stewardship: Engaging with companies and/or investment managers to improve on ESG metrics, as well as understanding their processes, can unlock value over time. Deborah Ng shared an example of a company that OTPP held through an external manager. The company received negative publicity, and OTPP engaged with the external manager to understand the company’s ESG practices. The external manager was able to show OTPP how they were addressing the issue with the company as well as restoring confidence in its ESG practices. The example underlined the importance of dialogue and building relationships.

The use of third-party ESG research 

ESG research and ratings providers have been scrutinized for inconsistency, as each provider follows a different research methodology. The consistency issue stems from a lack of an accepted standard for sustainability reporting. The Sustainability Accounting Standards Board (SASB), however, is a useful resource for best practices on ESG disclosures as it developed industry specific standards. SASB standards are also based on extensive consultation from companies and investors to understand materiality and the investment decision-making process.

The panelists agreed that insights can be obtained from third-party providers if investors and analysts are aware of potential inconsistencies. Ng advises the ratings should not be the endgame, but the underlying data can help analysts draw their own conclusions on a company’s ESG performance.

Investors, asset managers, and other industry members pay to access ESG ratings produced by data and research providers, unlike the situation with credit ratings. This has resulted in some companies being unaware of their ESG scores as determined by third-party data providers. Lindsay Patrick says there is an opportunity for ESG research firms to increase their transparency on ESG ratings, so companies can be more proactive and communicating their sustainability performance. MSCI ESG Research has started to address this issue by making their top-level ESG ratings publicly available for most of the companies in their investment universe.

Canada as an ESG Leader

Canada has a resource-based economy, and its dominance has overshadowed the country’s sustainability initiatives such as the carbon tax and commitments from energy companies to become carbon neutral. Ng advised that we could communicate our initiatives better globally; she also believes we should focus on the transition risk, as minimizing fossil fuels and natural gases too quickly can potentially disrupt the Canadian economy.

The panelists agreed that Canada has demonstrated leadership in sustainable investing. Patrick highlighted the pension fund community for their leading industry practices as well as robust corporate governance and ESG disclosures from the Canadian banking sector. Grosskopf reminded the audience that ESG research originated in Canadian markets: Michael Jantzi launched Toronto-based firm Janzti Research in 1992, for instance, which is now known as Sustainalytics; and MSCI established its ESG research through an acquisition of ESG firms that included Toronto-based Innovest.

Importance of sustainable investing moving forward: Summary

Overall, Lindsay Patrick recommends taking a holistic approach to sustainable investing to counter a tendency to assign companies simplistic assessment of being either being good or bad on ESG metrics. She believes there is tremendous value in adopting a view that every company can improve their sustainability performance, and so the industry focus should on embracing strategy, ambition, and targets.

In the past, ESG integration and social impact were seen as being on the opposite end of the spectrum from financial returns. Deborah Ng is seeing a convergence between these factors as companies realize they will need to provide a positive impact to society to be successful.

COVID-19 was used as a case study to demonstrate how sustainable investments showed resiliency when the markets experienced considerable volatility. A breakdown of the pandemic’s impact on ESG followed:

Environment: Cleantech companies, historically, have underperformed in market downturns as early adopters of solar energy carried higher volatility. Grosskopf attributed secular changes, such as the electrification of transportation, as one of the main reasons for the outperformance of sustainability-focused strategies during the most recent downturn. These changes are unlikely to be derailed by the pandemic, as it has driven significant capital spending within the economy where certain industries will be dictated by stimulus linked to green leadership. The European Green Deal, for instance, is a political commitment from the European Union to be climate neutral by 2050, demonstrating that this environmental initiative extends beyond a short-term trend.

Social: The focus within ESG, traditionally, been more on environmental and governance factors, as social aspects are less tangible and therefore easier to ignore from an investment perspective. COVID-19 brought the social factor to the forefront, with key issues including human capital management and health and safety, as well as customer and product safety. The pandemic has underlined the importance for companies of having robust practices in place to react quickly to crises, and to protect both their staff and customers.

Governance: The pandemic has drawn attention to key pillars in corporate governance, particularly around capital allocation and executive compensation. Several companies, such as Signet Jewelers, have reduced their executive pay and cut share buybacks to try and avoid job terminations. On the other hand, some companies have been scrutinized for issuing dividends to shareholders while laying off employees. COVID-19 will test the dynamics among stakeholders, as it remains to be seen if the burden of such governance actions will fall onto shareholders or employees.