By Bruno Bamberger, AXA IM Core Solutions Strategist
What you can measure you can manage. In responsible investment that has steadily become a practical reality, but thoughtful and analytical management is still required to make sense of sometimes uneven inputs and difficult comparisons.
For some issues, there are straightforward measurements. We can directly compare boardroom gender diversity. We can avoid companies that score as highly controversial using reliable third-party data. But to truly invest responsibly you get used to drawing on multiple sources, reviewing and assessing the credibility of external providers and developing your own robust review process.
Where once there was a lack of viable environmental, social and governance (ESG) datapoints, there are now multiple variations vying for attention. But still there remain no hard and fast rules on what data needs to be reported. Companies are often left to ask shareholders, advisers, or ESG ratings agencies to find out. And there is clearly a risk that crucial data can be omitted when there is no established template for which data to report – which could potentially result in a poor ESG score.
There is also an issue with scale. Major oil companies, for example, are able to publish annual sustainability reports running to 100-plus pages and requiring huge amounts of data and human resource to produce. In relative terms, this could penalise smaller, less well-resourced companies that lack the financial muscle to employ an army of ESG specialists to collect, collate and publicise their sustainability credentials. The unintended consequence may be to concentrate sustainable investment into larger capitalised companies.
Scores and more
It is important, therefore, that investors do not get too comfortable with an approach that might look simple on the surface. In brief, there is no shortcut to genuine responsible investment. An approach that we favour is to incorporate sustainability analysis into the portfolio construction process – to put ESG at the heart, from the start.
We think it works best to embed ESG analysis throughout investment teams, rather than in a separate silo. In our case, this includes more than 40 credit analysts and is an approach that has helped us ensure some 90% of eligible funds in equities, fixed income and multi-asset align with the most stringent parts of the European Union’s Sustainable Finance Disclosure Regulation (SFDR)[1].
Broad-based ESG scoring has evolved as a useful tool to guide investment decisions, and allows investors to seek out best-in-class companies. At AXA IM, we favour using MSCI scores as a base but aim to enhance those outputs with additional oversight – we layer our own research into that scoring system in a way that we think can both expand the coverage universe and address some of the inconsistencies that still exist in this area. In our view, this is the only viable way to authentically assess an issuer’s ESG credentials: To combine qualitative and quantitative research.
And so in our case, if a portfolio manager finds reasons to question an ESG score, they can commission one of our ESG analysts to perform a deep dive analysis which then goes before a committee led by heads of research across the business. They can then decide if an adjustment, up or down, is warranted. This kind of environment – where challenge and auditability sit side by side – reflects how we think investors should be handling ESG data.
Tracking emissions
Let’s look specifically at climate – altogether a trickier beast. Pension funds are moving towards the decarbonisation of portfolios, whether driven by regulatory changes, by the wishes of members or by the market-moving momentum around the issue. The question is how to manage and measure that process.
Absolute emissions are a great starting point and will be the ultimate gauge of a portfolio’s alignment with net zero. Weighted Average Carbon Intensity (known as ‘WACI’), can focus your analysis on how emissions relate to a common factor, such as revenues. Most people will be familiar with carbon footprint, which for pension funds can measure total emissions per million invested. But all three are a limited snapshot, frozen in time. We think it is important to expand our view to look at the carbon pathway of a business and across a total portfolio.
To do that, investors can look at data from the Transition Pathway Initiative (TPI), an asset owner-led group that scores companies’ preparedness for the low carbon economy. It is forward-looking, sector-specific, and freely available – its only real drawback is that it looks only at the most material emitting industries. Notably, it doesn’t cover financials, which may be financing high-emitting companies.
If we use this kind of data in tandem with the work of the Science-Based Targets initiative (SBTi) then we can form a viable picture of how a business might progress as the world works its way towards net zero (the SBTi checks and approves company targets against Paris Agreement climate goals and across more sectors than the TPI).
Getting engaged
Alignment to those goals is only one facet, however, and it is vital that asset managers remain focused on the financial objectives of a client’s portfolios. Climate Value at Risk (CVaR) is a useful tool in this respect (although the name is a little misleading). It is, in effect, a scenario analysis tool to measure how much a portfolio might fall if climate risks are fully priced in today. Investors can use CVaR to identify the main contributors to risk and better understand the potential financial impacts. Any increase in carbon pricing, for example, could quickly upset business models for high-emitting companies.
This overall approach reflects that need to combine the qualitative and the quantitative and it is clear that any assessment of the viability of emissions reduction plans must partly rely on an assessment of the quality of management – on their ability to deliver.
We think this offers a clear advantage to investors that take committed and targeted engagement very seriously indeed. It is another part of active management that simply cannot be replicated by using a passive approach. In a world where ESG targets in general – and climate goals in particular – can be fast-changing and hard to define, investors need a clear appreciation of management quality that runs alongside deep knowledge of the underlying data that will drive and define ESG performance.
The data that guides responsible investment has rapidly improved. But it is not perfect. There are still relatively few comparison points in ESG that can rival the simplicity of pure financial metrics. However, there is certainly enough now for an active and engaged asset manager to draw from, and enough to build portfolios that can aim to help protect against ESG risks, potentially identify where opportunities may lie, and aim to align with the goals of the Paris Agreement.
[1]https://www.axa-im.co.uk/media-centre/axa-im-announces-90-aum-classifie…
Disclaimer
This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.
Due to its simplification, this document is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
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The ESG data used in the investment process are based on ESG methodologies which rely in part on third party data, and in some cases are internally developed. They are subjective and may change over time. Despite several initiatives, the lack of harmonised definitions can make ESG criteria heterogeneous. As such, the different investment strategies that use ESG criteria and ESG reporting are difficult to compare with each other. Strategies that incorporate ESG criteria and those that incorporate sustainable development criteria may use ESG data that appear similar but which should be distinguished because their calculation method may be different.
The product categorisation is provided on the basis of the European Regulation (EU) 2019/2088 on sustainability disclosure in the financial services sector ("SFDR Regulation") and on the basis of knowledge at the time of creation of this document. To date, the regulatory technical standards related to SFDR are not yet finalised and remain subject to formal validation by the European Commission, the European Parliament and the Council. In addition, there may be further guidance on the interpretation of the SFDR Regulation. We are closely monitoring regulatory developments and the categorisation of products will be reassessed once these regulatory technical standards are published and may be subject to change.
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