Sustainable investing for a changing world
The trade-off between risk and return is well understood by investors. Sustainability is the third dimension, a forward looking holistic approach to investment.
A fifth of company earnings at risk from rising carbon prices
A new model developed by Schroders provides investors with a more accurate measure of how carbon costs will affect companies.
The extent to which company profits and investor returns could be at risk from tougher climate policies and higher carbon prices has been set out by a new model developed by Schroders.
The “Carbon Value at Risk” (Carbon VaR) framework, developed by the Sustainable investment team, highlights the inadequacies of traditional measures of climate risk and the problems investors face evaluating the impact of climate change on company profits.
Carbon VaR shows almost half of listed global companies would face a rise or fall of more than 20% in earnings if carbon prices rose to $100 a tonne.
A carbon price is a cost applied to pollution to encourage companies and other organisations to reduce the amount of greenhouse gases they emit.
Unlike usual carbon footprint measures, Carbon VaR focuses on companies’ business models and profit drivers rather than purely environmental measures.
The analysis shows carbon prices will have to be far higher than recent levels, reaching over $100 if the internationally agreed target of 2°C for global warming limit is to be met.
The effects on industries, companies and financial markets would be significant and widespread. Measuring and managing those risks is critical and requires the sort of innovative thinking Schroders is introducing today.
Percentage of earnings at risk from rising carbon costs
Source: Schroders and Datastream. Schroders portfolio value based on a hypothetical strategy comprising the five largest funds managed by Schroders. Calculated using constituents as of May 2017. For illustrative purposes only.
What is Carbon Value at Risk?
Carbon VaR measures the impact of rising carbon costs on a company’s profitability more accurately than those provided by carbon footprint analyses.
The effects of rising carbon prices on companies will be both dynamic and complex:
- Companies’ costs will rise in proportion to the total emissions generated by themselves and their suppliers.
- Selling prices are likely to rise to offset cost increases at an industry level.
- Demand should fall reflecting the sensitivity of customers to prices in each market affected, shrinking companies’ sales and costs.
Carbon VaR takes these linkages into account to gauge the impact on industry profits, using an estimating process to capture the three key variables of emissions, price and changing demand.
It’s also important to include all greenhouse gas emissions required to produce and sell a product, which conventional measures of carbon exposure do not.
The analysis also underlines the inadequacies of traditional measures of climate risk.
The problem with carbon footprints
Carbon footprints have become one of the most familiar ways for investors to gauge the impact of their investments on the environment.
A carbon footprint is a measure of the impact our activities have on the environment measured in units of carbon dioxide. So, if you drive a car to get to work or take a plane to go on holiday you leave a carbon footprint.
Businesses are the same. Everyday their operations create carbon emissions. A company’s carbon footprint typically relates the emissions it generates to its revenue or market capitalisation.
Such measures of “carbon intensity”, even if they are consistent, are often poor indicators of the effects of climate change on profitability or value. As a result, they provide little clue to the effect of carbon emissions on company earnings.
The curious case of Apple and Samsung
The example of Apple and Samsung is worth considering.
The two rivals sell fundamentally similar consumer electronics. Yet Samsung’s carbon footprint is significantly higher than Apple’s, because Apple outsources most of its manufacturing whereas Samsung manufactures more products itself.
In climate terms, this is an irrelevance: the emissions created by producing and selling both sets of products are in reality much the same.
To get an accurate picture, an investor clearly needs to get a handle not just on the company’s own emissions, but also those emanating from its suppliers. Carbon footprints, as currently conceived, don’t incorporate that information.
It follows that investors who rely on carbon footprints to guide their portfolios may face risks that they and their managers are not addressing.
Without innovative tools to help navigate a new environment of carbon reduction, investors will find it hard to reach their investment destinations, which is why the Carbon VaR model was created.
Read the full report
Also check out
Any security(s) mentioned above is for illustrative purpose only, not a recommendation to invest or divest.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Opinions stated are matters of judgment, which may change. Information herein is believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. Exchange rate changes may cause the value of the overseas investments to rise or fall. For risks associated with investment in securities in emerging and less developed markets, please refer to the relevant offering document.
The information contained in this document is provided for information purpose only and does not constitute any solicitation and offering of investment products. Potential investors should be aware that such investments involve market risk and should be regarded as long-term investments.
Derivatives carry a high degree of risk and should only be considered by sophisticated investors.
This material, including the website, has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.
Social and environmental change is happening faster than ever. The challenges posed by climate change, inequality and demographics are sizeable. Those companies able to adapt and thrive will continue to benefit disproportionately, while others will fall further behind.
For fund managers navigating this backdrop to deliver value is a challenge. Our answer to this is sustainable investing. We focus on identifying sustainably managed businesses, understanding the risks and opportunities of environmental and social change, and actively engaging to improve companies behaviours and governance. At Schroders this is how we believe we can create real long-term value for our clients.
The Schroders story by numbers
Source: Schroders, as at July 2017 unless otherwise stated
1 As at 31 December 2016
2 PRI, 2015, 2016 and 2017 Assessment Reports.
Companies at the centre of analysis
Companies are at the centre of the framework and we monitor their abilities to navigate the social and environmental trends in their industries. This understanding is key to analysing a company’s effective ownership and management for us to see the company as a good long term investment. ESG analysis is unlikely to present a performance signal in isolation, but as part of an integrated view of a company it can be compelling.
As an active manager, company engagement happens on a daily basis across Schroders. The aim of our engagement is threefold:
- To encourage companies to adopt longer-term approaches to their stakeholder relationships;
- To improve investment insights on emerging risks and opportunities; and
- To generate better returns.
Source: Schroders, as at 31 December 2016. Governance engagements are included from 2014 onwards.
Find out more
Please visit the Integrity page to discover how we uncover long-term potential, together with our ESG policies.
Also check out the Influence page to see how we use our vote to act in your best interest.
Please visit the Insights page to explore our investment insights through a sustainability lens.
Knowing what to do with insights is the key that unlocks value for you. Find out how our analysis applies in practice from the Interpret page.
Until a decade ago, environmental and social considerations did not really register in the investment industry outside niche ethical or green corners.
The UN Principles for Responsible Investment which were launched in 2006 kick started a change and required investors to consider ESG factors as part of their investment decisions, ownership, engagement and reporting.
Over a decade the PRI has gone from launch to counting over nine in every ten of the largest fund managers in the world as signatories.
Schroders have been conducting business in this way long before the principles were launch due to our strong ESG convictions, beliefs and as part of ingrained investment approach. We became a signatory in 2007.
ESG Trend: It’s important to other asset owners too
Source: PRI, as at 30 April 2016 (https://www.unpri.org/about).
Global ESG assets by region
Source: ‘2016 Global Sustainable Investment Review’, Global Sustainable Investment Alliance (GSIA),*Proportion of SRI assets relative to total managed assets.
Evolution by strategy
Source: 2016 Global Sustainable Investment Review, Global Sustainable Investment Alliance, GSIA.
Find out more
Please also check out the brochure where we layout Schroders’ view on the landscape of activities, strategies that fall under the broad umbrella of ESG and sustainability, and our assessment of the terms most commonly associated with each.
As a firm with an integrated ESG investment approach across asset classes and geographies – and a long term investment focus - we are pleased that the statistics from the “Schroders Global Investor Study 2016” suggest that a majority of investors feel the same way as we do.
Encouragingly 86% of investors in Hong Kong were willing to stick with an ESG investment for longer. The indication given was that this was 2.2 years longer than the average period of 3.4 that investors usually hold onto investment.
Given the general calls for a more long term approach in finance generally this is encouraging.
A willingness to invest for longer in ESG investments
Source: Schroders Global Investor Study, conducted between 30 March and 25 April 2016.
Hong Kong is responsibly minded
How important are each of the following ESG issues to your choice of investments?
Source: Schroders Global Investor Survey (2016) - Global Consumers.
Scores above are out of 10.
Would you move, or consider moving, your money out of an investment that was performing well, if you discovered it was invested in the following types of companies?
Source: Schroders Global Investor Survey (2016) - Global Consumers.
Find out more
Please click here for more information on the Schroders Global Investor Study 2016.
Experts from Schroders discussed why there is more to ESG investing than tracking a sustainability index, and why ESG is about navigating future forward change in an article for the publication Asia Asset Management. Jessica Ground, Global Head of Stewardship, and Chris Durack, Chief Executive Officer, Hong Kong & Head of Institutional Business, Asia Pacific for Schroders give their views and opinions on the topic.
Navigating future forward change
A+1 UN PRI-rated Schroders explains why there is more to ESG investing than tracking a sustainability index
Schroders believes sustainable investing is all about allocating capital for the future.
As Environmental, Social and Corporate Governance (ESG) moves up investors’ agenda, there is a growing trend in the industry towards products that track a sustainability index.
But Jessica Ground, Global Head of Stewardship at Schroders, thinks an active approach is needed to capture the benefits of ESG investing.
She explains that ESG investing is incredibly complex, for example, incorporating climate change into an investment strategy has many different aspects ranging from governments’ responses to climate change, to how consumers may modify their own behaviour.
“It is very hard to do this passively,” she says.
Ms. Ground thinks another issue with ESG indexes is that they tend to be quite backwards looking, based on historic data.
“ESG is really about navigating future forward change. It can’t necessarily be distilled in a passive approach,” she says.
She also points out that while the quality of ESG data is improving, it is still not systematically at the same level as other investment data, for example 40% of carbon data is estimated.
“Some of the passive strategies have been low carbon strategies. But if you have a passive approach on imperfect information, it is not a great outcome,” she says.
By contrast, Schroders takes a very active approach to its ESG investment process.
Holding companies to account
Ms. Ground explains that while around 8.6% of the assets the group manages have some kind of ethical exclusion, such as not putting money into tobacco companies, Schroders has 20-plus years of firm-wide experience of ESG integration, and this is the investment strategy it pursues for the vast majority of its clients.
“We see our job as allocating capital for the future and we really believe that in doing that we need to understand how the world is going to change.
“ESG provides us with tools that help us think about the future and it helps us assess which companies are best placed to navigate that,” she says.
Schroders has 11 dedicated ESG specialists, who work with more than 200 equity and credit analysts across its global locations2.
Ms. Ground says such an approach can definitely generate alpha.
Schroder’s ESG strategy goes further than just picking companies that look likely to benefit from future changes.
“The other area of ESG that is very important to us is the idea of holding companies to account,” Ms. Ground says.
“We as shareholders can engage companies to get improvements, and we have a really powerful seat at the table to get change on ESG issues.”
In fact, Schroders had more than 760 engagements with companies in 2016 alone, while it voted in more than 5,160 company meetings during the year.
Nor does Ms. Ground think investors have to sacrifice performance for their principles.
“There is a great body of academic evidence that looks at this issue.
Companies that have good governance tend to have much more resilient operational performance in the profits,” she says.
“What is interesting is that also gets recognised by the capital markets, so they have lower costs of debt borrowing and equity.”
Why bother engaging with companies?
Successful engagements have benefitted holdings
Source: Dimson, Karakas and Li (2015). Fama-French size decile returns from Professor French’s website.
Sustainability as risk management
Responsible investing can also be a good tool for managing risk and safeguarding investments.
Ms. Ground gives the example of a piece of research carried out by Schroders in which three catalysts are identified that could result in sugar causing Big Food to become the next Big Tobacco.
She points out that over consumption of sugar is leading to obesity, heart disease and diabetes. There is a rising awareness of this issue among consumers and governments, which creates an ongoing headwind for companies.
As a result, these firms could face lower sales growth and pressure on profit margins as they have to increase research and development investment.
But certain firms, such as those that have already invested heavily in R&D and implemented nutritional profiling across their product portfolio, are better placed to increase their market share and become market leaders.
Ms. Ground says: “Through the research, we really identified winners and losers, with some companies already addressing the issue, but other companies lagging.”
The research also looked at the fact that sugar in the US is labelled in more than 40 different ways, and given that the US is a litigious society and has an obesity problem, there were likely to be legal cases against food companies.
Ms. Ground says that when accounting for potential litigation costs, lower sales growth and increased research and development investment, the impact on financials over the medium-term could be material.
“We identified a different risk. The first aspect, talking about declining consumption and margin trends, appealed to our equity investors, but the previously unidentified litigation risk appealed to our debt investors, who were able to position portfolios around it.
“You can see from that initial work there are multiple ways that we can generate alpha from this.”
Ms. Ground points out that realistically, with more than half a trillion dollars of assets under management worldwide, Schroders was always going to have some exposure to issues such as the one relating to sugar.
But on the back of the research it has organised round tables with companies to discuss the issue and how they might disclose better on the sugar content in their portfolios, and make progress on the issue.
“We can really start to monitor and make sure they are doing something and taking it seriously,” she says.
“It is about managing these risks in a way that can benefit portfolios.”
What gets monitored gets managed
Ms. Ground advises companies that want to score highly on the sustainability front to focus on the material issues for their company.
“What are the most important stakeholder relationships and how can you get them on to a sustainable footing.
“Make sure you are forward looking and really thinking about how our world is changing, and moving ahead of that.”
“We know people are taking them seriously when they also put KPIs around them and monitor them.
“It is the adage what gets monitored gets managed,” she says.
But Ms. Ground adds that the targets had to make sense for the business.
“If you are an oil and gas company are you monitoring your carbon emissions and expecting carbon to get taxed?
“That is incredibly important and there is a real difference to saying we care about the environment, and this is how we are reducing our carbon footprint,” she says.
Endowments lead the way
Schroders has found that globally ESG is particularly high up the agenda of endowments.
“We see endowments leading the way and a lot of them really wanting to align their mission with how they are investing. They see their investments as an extension of this,” Ms. Ground says.
Many sovereign wealth funds also place an emphasis on ESG as they think about the long-term sustainability of the world as major asset owners, while there is also increasing interest from pension funds.
Ms. Ground explains that this interest comes from the fact that younger investors feel very strongly about sustainability issues and ask more questions about them.
At the same time, millennials are starting to work in pension funds themselves and they are focused on creating change.
Growing opportunities in Asia
Ms. Ground says data showed there was also a high interest in ESG investing in Asia, particularly among young people.
A global survey found that 59% of millennials in Asia thought the issue of climate change was very pressing, compared with just 30% in North America.
“I wouldn’t be surprised if Asia leap frogged other regions in terms of ESG investing,” Ms. Ground says.
“Asia has less history in this area but because things are changing so quickly, they can start with a more innovative approach, not just having polices but setting targets and measuring things.”
She adds that policymakers in Asia were encouraging engagement with ESG issues, and there was a rise of stewardship codes in Taiwan, Singapore and Hong Kong.
Ms. Ground thinks Asia is also well positioned to learn from the mistakes of other regions.
She says in Europe there have been cases of green washing, where companies had put ESG policies in place but not really done anything else.
In other cases, investors had excluded coal companies from their portfolios, but this had not actually led to a reduction in the number of coal mines in operation.
She says: “Let’s learn from the mistakes and move away from the green washing and just look at how as a pension fund you can really invest in a more sustainable way, and how as a business owner you can create a really long term sustainable business that is going to last.
“There is a ground swell of opportunity.”
Chris Durack, Chief Executive Officer, Hong Kong & Head of Institutional Business, Asia Pacific, at Schroders, says: “As an active fund manager committed to fundamental research we have the benefit of understanding that companies’ futures are intrinsically linked to the environment in which they operate.”
“We are looking to use our combined resources and experience to gain better insights from how we link a view of social and environmental change to company analysis and investment decisions.”
“While parts of the industry are still asking whether ESG factors can affect performance, we have moved forward and are focusing on how to define and measure ESG factors to maximise their benefit for our clients.”
Important Information: This document is intended to be for information purposes only and does not constitute any solicitation and offering of investment products. Investment involves risks. This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.
Source: Asia Asset Management July 2017
Find out more
Sustainable investing is growing in popularity, but many misconceptions remain. We have the myths debunked for you, please click here to find out.
Please also visit the Insights page to explore our investment insights through a sustainability lens.