Fire your money managers…
…was the key take-away from Sir Christopher Hohn’s recent presentation at J. P. Morgan’s ESG Thought Leadership Forum. The Children’s Investment Fund Management founder and philanthropist urged that voluntary action isn’t working in the fight against climate change, with emissions continuing to rise - a massive 35% of total emissions are from companies. Urgency is essential, and inevitably a wave of regulation, taxation and litigation is coming their way. Without decarbonisation, companies will experience further taxation, higher operating costs and disruption from cleaner technologies, and the money managers not helping to force this change will suffer.
I was due to write my usual ESG Committee Chair end of year summary this December, but this sentiment resonated with me. Or in fact, it is what was not said, and what continues to not be said, that resonated with me. So instead, I thought I would better use this time to highlight what was not touched upon, and in fact is too often overlooked.
The urgency and breadth of change required is also a key theme of COP26’s mobilising finance agenda. This states that to achieve climate goals, every company, every financial firm, every bank, insurer and investor will need to change. If all parts of the financial chain must evolve to achieve climate goals, ESG Impact and Exclusion strategies alone cannot hope to achieve this. We saw for ourselves (on a relatively small scale) in Q1 this year the repercussions when high profile ESG stocks and ETFs become overcrowded. There is a world between ESG exclusions and Impact Investing, and it is essential that we embrace it.
This is where ESG Integration strategies, the ability for investment managers to integrate ESG principles and data into existing fund strategies, can provide some much-needed assistance to its older sibling, Impact. Whilst impact investment will invest into a renewable company, ESG integration can find the bank or industrial company that is changing the way it interacts. At Velox, we have integrated ESG factors as an additional layer of information and insight across our established process. Our proprietary industry specific systems and technologies seamlessly integrate ESG risk factors and opportunities across the entire investment process. In doing so, we consider ESG alongside our long standing fundamental, technical, sentiment and catalyst analysis - identifying such risks and opportunities, whilst maintaining a market neutral long-short strategy.
Why are ESG Integration strategies not being spoken about more? Understanding external integration strategies, and defining internals ones, can be complicated and subjective for many allocators. Aligning the external and internal more complicated still. There is no one-size fits all and many concepts, such as ESG shorting, have not been navigated by the more ESG experienced Long Onlys and remain wide open for debate. This could explain why ESG Impact strategies saw assets increase by 52% in 2020 and 39% up to September in 2021, yet potential ESG Integration strategies only experienced flows of 2% over these periods (data source: GS and Morningstar) - a deeply worrying statistic for climate goals. At Velox, we have experienced this trend, but encouragingly, through the second half of the year we have seen allocators come up the curve, often (but not always), driven by the motivations of asset owners.
SFDR has made this simpler for some, and whilst the concept is good, its implementation has been plagued by delays. Currently, many allocators have concluded (much like they did for UN PRI through 2020) that the label alone is not sufficient in giving a 360 view on the effectiveness of ESG initiatives and the extent of adoption within a manager. It has, however, helped flush out some of the green-washers that previously gave investors the impression that the investment universe was full of ESG funds in a multitude of strategies. 2021 saw nearly USD3 trillion of funds strip ESG tags from their name due to the higher regulation surrounding ESG compliance (source: Bloomberg Intelligence). Impact strategies aside, there is currently a dearth of available funds and strategies that effectively fulfil the ESG mandate.
At the start of 2019, Velox integrated ESG into an investment strategy that has existed since 2015, but within the integration process, made a conscious decision not to update the investment strategy name to include ESG, SRI or similar. Why? We believe that the standard by which we implement and continue to develop our ESG integration within the investment strategy must, in the next 5 years, become the norm. As such, rendering any name change futile and undermining our firm’s ethos. Just like the outcome of COP26, echoed by Sir Christopher Hohn, we believe that unless managers across ALL strategies evolve to contribute to sustainable goals, or at very least identify the associated risks, there will be no place for them in the future. Most strategies cannot, whilst maintaining their identity, evolve to be an Impact strategy – they must integrate ESG principles to survive.
FinTechs have created tools to help managers – but all too often one size does not fit all, and costs can be high. Banks are making information more accessible for their clients, and often at no additional cost (such as GS’s impressive new carbon portfolio analytics tool). This is a great step forward, but is predominately a top down view. In order to maintain identity and consistency, the evolution and innovation must be strategy and firm specific, built from bottom-up and in a way that works with the existing investment process.
Before I sign-off for another year, I could not comment on ESG integration without insisting that it is not just for Christmas - or in this case, the investment strategy. True integration must first start at the firm, and ultimately the people contributing to running it. Our people and the identity we wanted to create for Velox is where it started for us, and is what inspires our continued efforts to maintain our values and fulfil our commitments. I’m proud to say that this year, in addition to our efforts to date, the firm has become carbon neutral, and in 2022 we are excited to announce several ‘women in investment’ initiatives - doing what we can to combat the shortage of women in investment roles. We continue to expand and refine the ESG initiatives within the investment strategy, which analysis shows us encourages a natural transition of the fund’s holdings towards positions with stronger ESG credentials (81% as of 15 December 2021, according to companies in the top 2 quartiles of Velox's proprietary ESG Traffic Light System). If you’d like to find out more about Velox and our integration of ESG, please contact firstname.lastname@example.org.
Wishing everyone a joyful and COVID free festive period. Until next year…