ESG survey: no need to accept lower returns over long term

Author: John Crabb | Published: 4 Dec 2019
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Although some parts of the industry already do so, it is not necessary to accept lower returns from ESG products in the capital markets or other financial investments. Richard Mattison, CEO at Trucost ESG Analysis, part of S&P Global, said that the sacrifice is unnecessary in the long term.

Speaking to IFLR for our special report on ESG, Mattison said that industry discussions about lower returns tend to refer to cycles of one to four years maximum, which does not reflect the lifecycle of the average investment or pension fund.

We asked a number of ESG managers from banks and asset managers whether they would be willing to accept lower returns for ESG products. An overwhelming 80% of respondents said that they would.

Mattison, however, does not feel that this is necessary.

"Firms should not be willing to accept lower returns over the average time horizon of a pension fund. In the long term they should actually expect higher returns," he said.

See also: ESG: Asset managers vary in enthusiasm

In his view firms can easily create passive investment structures, funds or indices that can accurately mirror a benchmark while reducing CO2 by up to 40 or 50% over time. "You don't have to sacrifice returns at all. That is a purely quantitative-based approach in the context of an index," he added.

The difficulty on the active side is that when sceptics cite volatility and lack of return, they discuss a wide range of different investments, from early-stage sustainable tech all the way to offshore wind, which now reliably produces energy at cheaper costs than normal grids. "There are ways of creating investment structures that reliably mirror benchmarks that look at and replicate returns while creating more desirable societal outcomes," said Mattison.

Tim Cameron, head of the asset management group at the Securities Industry and Financial Markets Association, told IFLR that in his experience asset managers don't actually expect lower returns. "They can be competitive and not necessarily accept lower returns. It's part of the competitive evaluation. Most people who act in the ESG space tell you they are going to be competitive with market-appropriate benchmarks," he said.

On the in-house side, Emily Chew, global head of ESG research and integration at Manulife Investment Management, said that her firm believes sustainability helps to drive financial value, and does not view it as necessary or desirable to accept lower returns in order to integrate ESG factors into analysis.

"The ability to create financial value depends on the health of our natural environment and the strength of the social infrastructure in our communities. As such, we believe that ESG analysis is integral to understanding the true value of an investment," she said.

"Conversely, we believe it will probably become necessary to accept lower returns if sustainability is not considered in investment decisions."

See also: High hopes for EU sustainable finance taxonomy

Sustainability will arguably be the most significant mega-trend shaping the world’s economy over the coming decades. As sustainability themes increasingly come to the fore for the companies in which firms invest, the research-driven contextual insight of active investment managers will be critical for properly assessing and responding to the related risks and opportunities for clients.

Is it already happening?

In conversation with a number of survey respondents, it became clear that in certain parts of the market, ESG products are already outperforming their conventional counterparts.

Anne van Riel, head of sustainable finance in the Americas for ING, said that her firm offers sustainability-linked loan products with a discount - albeit small - if companies meet ESG targets.

"We are a corporate and we need to make our returns, so we accept marginal discounts and we see a risk-return trade-off. We ultimately believe that companies that have better polices in place have a better ESG performance, and also have lower risk," she said. "From a risk-return perspective it still meets our interests. Ultimately, longer term, that profile should remain intact, and if you accept lower returns you should also be met with lower risks."

An EU-based asset manager also confirmed that it is already happening, and added that the reverse is also becoming true. Essentially, there is a link between ESG and credit risk, but it is typically long term.

"If you are willing to accept a lower return on the short term stability when the connection between ESG and credit is in the long term, the reality is you may have a shorter facility with the client, or you may have a long term security with the client," they added. "Influencing the behaviour of the client in the short term may be important, not for the short term facility, but for the long term security that you also have on the books."

In the future it is not impossible to imagine that adequacy ratios for banks are tilted in favour of green - or disincentivise brown by creating a prudential measure to rebalance portfolios towards green.

Read the full survey here

See also: Critical challenges facing the green bond market