Interview with Vicki Bakhshi

Answers by:
Vicki Bakhshi, Director, Governance & Sustainable Investment di BMO Global Asset Management

The case for using ESG factors to support risk management looks strong. But can it also generate investment opportunities?

Much of the investor debate on ESG in the past few years has focused on risk. And indeed there is compelling evidence of the materiality of ESG factors in terms of downside risk protection. Barclays, for instance, compared a group of bond issuing companies with strong governance performance with a second group with weaker governance – the first group had a significantly lower instance of credit downgrades over a six year period.

The opportunity side of the equation has had less attention. But we believe that it is equally compelling. However, it requires a somewhat different frame of analysis as compared with risk. When we consider ESG risks, the data and research we focus on usually relates to the way the company operates. Does the Board structure follow best practice? Has it got its greenhouse gas emissions under control? Does it have hidden risks within its supply chain?

When it comes to opportunities we shift our thinking towards what the company actually produces and sells. And the fact is, sustainability sells. The world is facing a range of challenges that need solutions – from clean energy, to public health, to plastics alternatives, to social care. Looking forward, companies providing these solutions should be well-positioned for growth, and for superior risk-adjusted returns as compared with those in more ‘sunset’ industries.

In terms of identifying what these potential growth areas are, we see the Sustainable Development Goals (SDGs) as particularly valuable. These 17 goals, agreed by over 190 governments worldwide, set out a vision for a more sustainable world by 2030. In our Responsible Global Equity and Responsible Emerging Market Equity strategies, we have mapped our investments to the SDGs in order to understand how our stock selection decisions correlate with the much wider macro-level trends identified in these goals. We see a growing number of corporates doing exactly the same in their own reporting.

Can looking at ESG factors as part of an integrated analysis of companies produce better-quality investment decisions that enhance long-term fund performance?

The integration of ESG factors into investment strategies is now commonplace amongst European asset managers. However, whether this actually adds value depends on exactly how this integration takes place. A ‘tick-box’ exercise, where fund managers review ESG data as a due diligence exercise separate to the actual stock analysis and valuation, is unlikely to produce tangible results. However, if ESG analysis – including both risk and opportunity elements – is an integral part of stock analysis then it has the potential to offer a richer and more rounded view of the long-term prospects of the investee company. In this case ESG factors are more likely to affect the ultimate valuation, through being incorporated, for instance, into the discount rate applied if they affect the analyst’s opinion of the quality of management at the company; or the revenue projections used, where sustainability trends may lead an analyst to be more optimistic about future sales.

Our fundamental equity teams also believe that ESG factors provide a valuable angle on a concept which is central to their stock selection decisions – the ‘moat’, or the factors that protect a company from having its performance eroded by competitors. Having a strong sustainability profile, for instance, can build a better brand and reputation, so helping to ensure customer loyalty and avoid losing market share.

Engagement can further enrich this process. Through a two-way dialogue with companies on factors such as governance or sustainability we can build a better picture of the future prospects for the company’s success.

Climate change presents a potential systemic risk to companies in key sectors. Why should investors pay attention?

Whereas many ESG issues apply to a single company or perhaps a sector, climate change presents both risks and opportunities that are cross-sectoral and cross-regional. The transition to a low-carbon global economy presents a fundamental macroeconomic shift that has widespread implications but whose economic implications are yet to be fully understood. In addition, even if governments and business succeed in controlling emissions, we will still experience further physical changes in the climate which could have a significant impact on sectors such as food and agriculture, as well as profound social effects.

Investors who continue to invest on a ‘business as usual’ basis risk being taken by surprise by these changes. Already, the falling costs of renewable energy technologies are having a transformational impact on the energy industry. There are steps that investors can take to be more proactive. We see the recommendations of the Taskforce on Climate-related Financial Disclosures as providing very valuable guidance on how investors can develop a strategic approach on the issue.