Responsible investing (RI) is gaining significant momentum, with investors seeking to incorporate environmental, social, and governance (ESG) factors into their portfolios. Dustyn Lanz, CEO at the Responsible Investment Association (RIA), and Nalini Feuilloley, director, responsible investment, at BMO Global Asset Management, provided individual presentations on trends in RI at the CFA Society Toronto event, Emerging Trends in Responsible Investing on October 15, 2019, at CFA Society Toronto’s offices.

Responsible investment strategies
A common misconception about RI is that it consists of just one strategy: exclusionary screening. There are many approaches to RI, however — these strategies, sorted by prominence in Canada, include:

• ESG integration, which incorporates ESG information into financial analysis;
• shareholder engagement, which uses shareholder power such as proxy voting to influence corporate behaviour in order to improve a company’s sustainability profile;
• positive or negative screening, where the latter often involves avoiding “sin” stocks like tobacco companies, and the former is a best-in-class analysis that identifies ESG leaders within its investment universe;
• impact investing, which uses investing to solve specific environmental and/or social challenges; and
• thematic investing, which uses ESG-themed funds such as clean technology and women in leadership.

The evolution of responsible investing: A timeline
RI has its roots in the 1970s and 1980s, when the practice of negative screening was used with the goal of abolishing apartheid in South Africa. After continuous development in the 1990s, the turn of the century marked the beginning of a major growth phase for RI:

• the United Nations (UN) launched the Principles for Responsible Investment (PRI) in 2006, six voluntary principles institutional investors sign committing to integrate RI into their practices;
• the Sustainability Accounting Standards Board (SASB) was founded in 2011, to help investors identify material ESG factors in each sector;
• the UN introduced the Sustainable Development Goals in 2015;
• the Paris Climate Agreement was signed at the end of 2015; and
• the Task Force on Climate-related Financial Disclosure was created in 2015 to harmonize reporting practices on climate-related financial disclosures.

What does responsible investing look like in Canada?
During his presentation, Dustyn Lanz, CEO at the Responsible Investment Association (RIA), stated that he doesn’t consider RI to be a niche investment universe as it has been largely adopted by some of the largest and most sophisticated investors in the country. Based on a 2018 RIA study, RI in Canada has experienced a massive growth since 2011, with 80 per cent of these assets held by institutional investors. The study also found that RI assets accounted for roughly 50 per cent of all Canadian assets under management.

From a retail perspective, the RIA study showed more than half of Canadian investors are interested in RI but know little or nothing about it. Lanz refers to this as the RI awareness gap, which presents a significant opportunity for investment professionals to gain the expertise to engage their clients.

The study found millennials are more than twice as likely than their parents’ generation to be interested in investments focused on solving environmental and/or social issues. The study also showed that almost a quarter of women are more likely than men to believe it’s important for their advisors to be knowledgeable about RI. These trends will have a significant market impact as a huge wealth transfer is expected to occur in upcoming years.

Two major themes in RI: Climate change and board diversity
Climate change has three key investor risks:

• physical risk, including more severe and frequent extreme weather-related events such as floods and wildfires, which can destabilize supply chains and disrupt business operations;
• transition risk, which is the result of an adjustment towards a low carbon economy such as changes in regulation, consumer preferences, and production methods; and
• liability risk, where individuals who feel they’ve been harmed by climate change may seek compensation (over 1,000 lawsuits have been filed worldwide against companies alleging responsibility for climate change).

Lanz illustrated his presentation on board diversity with a photo of a typical corporate board with zero gender or racial diversification. Lanz noted about a quarter of Canadian boards in publicly traded companies don’t have women and/or other diverse representation, though research has shown it can provide a boost to a variety of important financial metrics.

The driving forces of responsible investment
Following this RI primer, Nalini Feuilloley, director, responsible investment at BMO Global Asset Management, delved into the three main drivers of RI: materiality, market demand, and regulation.

Materiality
ESG issues are material in assessing company value, Feuilloley said, and there is no avoiding the risks and erosion of shareholder value that will come from the effects of climate change. An excellent point of reference for those trying to integrate ESG more broadly into their investment process is the SASB materiality framework.

She discussed some examples of recent material ESG issues: 

• 2010, BP oil spill in the Gulf of Mexico: BP eventually paid the largest environmental fine in U.S. history, negatively impacting company value.
• 2014, Volkswagon emissions scandal: the price dropped and the company paid enormous fines.
• 2018, Tesla: Tesla’s price dropped when the SEC filed suit against Elon Musk for fraud.

Market demand
Feuilloley says that demand for RI has grown rapidly on the asset owner side, with two-thirds asking about ESG in their Request for Proposals (RFPs) to investment managers. They view ESG risks as material, and want to know their investment managers are integrating these risks across their entire plan. Those wanting to earn that business need robust answers to these questions, as many asset owners will press for assessment scores (if member of the PRI) or examples of engagement.

Regulation
There has been a lot of change in the regulatory environment regarding RI, with the United Nations-supported PRI (Principles for Responsible Investment) network estimating over 300 policies having been created or amended in the last five years.

• In 2015, the Financial Services Commission of Ontario (FSCO) mandated pension plans regulated in Ontario to disclose how they are integrating ESG in their statement of investment policies and procedures.
• In 2019, the EU Commission action plan on sustainable finance launched a recommendation for a classification system for environmentally sustainable economic activities, setting performance thresholds for activities and disclosure requirements.
• In Canada, a federally appointed Expert Panel on Sustainable Finance released a report in June 2019 with 15 recommendations focusing on the opportunity side of climate change, harnessing these opportunities, the foundations for creating scale to mainstream sustainable finance, and financial products in the market centered on transition.

With the Paris climate accord and its 2030 deadline looming ahead of us, Feuilloley says, experts are predicting an inevitable policy response with eventual government intervention in several countries, which will impact financial markets and investors. The best solution to mitigating this risk is to prepare and get ahead of it.

Overall, the discussion brought significant insight into how RI has evolved over time, and the examination of driving forces gave the audience a better understanding of the inherent risks to investors.