Time to get real about ESG scoring as integration accelerates Investment MagazineRead More
Impact Investing Forum 2024
London. April 24-25, 2023.
Edward Lees, cohead of BNP Paribas Asset Management’s Fundamental Active Equities’ Environmental Strategies Group, says that there has never been a better time or a more difficult time to invest with a focus towards sustainability.
Lees highlighted the enormous opportunities and challenges of investing and allocating capital in a sustainable manner on the eve the November United Nations Climate Change Conference (COP26). This was also witnessed alongside the passage by the United States President Joe Biden of the Infrastructure Bill – which will see tens to billions of dollars flow into clean energy projects.
Lees stated that global pacts and the allocation of government capital aside; the ongoing movement by allocators, investment managers, towards integrating ESG into stock selection and portfolio construction, strategic asset allocation decisions, and portfolio construction makes the interrogation and measurement of ESG critical.
Edward Lees People are being caught, greenwashing is becoming more common and is being exposed. Lees stated that investors must move beyond choosing companies and allocating capital based on an ESG score in an interview with Investment Magazine.
There has been significant progress on the backs of global agreements like the Institutional Investors Group on Climate Change, UN Principles for Responsible Investment and other initiatives such as the European Union taxonomy for Sustainable Activities designed to standardise, measure and standardise progress towards sustainability goals. However, Lees has highlighted that there are growing instances of appropriation by investors and companies looking to benefit from the ESG movement’s uptake.
ESG scores have become a way to get instant credibility and to benefit from the ESG hype, Lees explained. Despite not having genuine sustainability credentials, Lees pointed out the many “false positivities” that ESG scoring can bring up.
How do you know if a company’s actions are important? Lees stated that you do this by paying close attention to the company’s bottom-up, through detailed revenue segmentation analysis and capex segmentation. Understanding where their money is coming from, where it is going, and where it is focused, and what they are developing.
Lees pointed out that false positives are a common outcome when ESG scoring isn’t properly questioned. Companies with high sustainability impacts can have low ESG scores. This is because they may not be able to devote enough staff to reporting. However, companies that are less desirable from a sustainability perspective might be highly rated depending upon how their scores are weighted.
Many companies that are highly rated by BNP Paribas Asset management’s scoring system may not be as highly rated in other ESG scoring systems. This is because they are smaller companies and might not have the resources to dedicate to their ESG policies.
“If you were to go today to any ESG system and only picked companies with high scores, the hit rate for real impact would be very low.” Lees stated that impact wouldn’t correlate as well with ESG scores as you might think.
Lees is based in London’s headquarters of BNP Paribas Asset Management. He works with the sustainability centre, which employs 28 people worldwide. A quantitative research group also assists the firm to bring its proprietary research to the activities and companies within its investing universe. Over the years, the investment firm has developed its sustainability center to integrate ESG into its mainstream investments teams. Lees said that BNP Paribas Asset Management is now known as the “sustainable investor for a changing planet” because of its culmination of these efforts.
Integration is our strength
ESG and sustainable investing have seen rapid growth in recent years. Australia is now at least on par with European countries in mainstream investing integration according to Kylie Willment (chief investment officer at Mercer Australia).
Willment outlines the many focuses that CIOs and investment team members at funds have today. These include generating strong returns while managing risks and navigating a climate transition that is still uncertain.
Willment explained that the current focus is on building more sustainably-themed strategies at the asset allocation level or SAA level, so that we have structural components that are very focused on transitioning to a low carbon future.
“When it comes down to selecting managers, it’s about us being confident that the managers we bring into our portfolios are integrating ESG in their own decision making. She added that portfolio construction elements are also important.
Willment stressed the importance of investment teams having key responsibilities or KPIs in ESG, besides (or in addition) rating a manager’s EGS credentials.
It must be a part of the investment team, from the top to the portfolio managers. We used to see a lot of ESG teams that produced a lot of interesting research, but the portfolio managers didn’t notice it. She said that if it’s not an integral belief among your portfolio managers, it’s unlikely to be taken seriously within the portfolio.
Willment also stressed the importance of investment firms demonstrating the results of their ESG integration through case studies and other examples of stewardship, including voting, and where engagement has resulted behavioural changes with companies.
Kirsten Temple, manager for research at JANA Investment Advisers, stated that “it’s never enough for an organization to have a great policy or good research. We always want to understand how it’s used within the portfolio context.”
“I think we were once more sensitive to the individual approaches of managers to ESG integration. She said that you have to be able to show it, regardless of your approach or how structured your standard practices around non-ESG factors.
Temple stated that it’s the issue of engagement that consultants and asset managers are pushing investment firms towards being more accountable.
“There is a strong expectation that if your company is going to be held, and you can see problems, you will need to be talking with the companies and pushing for those issues to get resolved. Companies must report now to ensure you have the data. Now it’s down to how meaningfully they are engaging.
According to Lees of BNP Paribas Asset Management, divestment should be the most important hurdle in engagement.
Firms must publish the extent to that they vote against companies at AGMs. They need to review these proxy reports every quarter. Then, they need data analysis to determine the impact of their voting on companies they invest in. Once they have these metrics, they should hold themselves accountable, Lees explained.
According to the firm’s latest disclosures, BNP Paribas asset Management voted against 34% of resolutions at the 2021 AGM season. This is according to 1,684 AGMs in Europe, North America, and Asia. According to data, it supported 90% of climate-related shareholder resolutions while rejecting 37% of resolutions related to director elections on grounds of diversity.
Lees said, “But I think that proper engagement goes beyond that [shareholder vote and divestment],”
He said, “Engagement can be a lot more difficult for asset management businesses and it naturally sits with PMs [portfolio mangers] who own the positions. They really have that one-on-1 time with the CEOs or the CFOs and really push them to really change operationally what’s happening.”
“And those are more like ad-hoc situations [where PMs could meaningfully influence operational changes], in my experience this doesn’t happen all that often, but they are great stories whenever they do happen… firms who try to suggest they do that all of the time I would be skeptical of because I don’t believe that the overlap between those genuine opportunities in market and in your shareholding situation are all that common.”
Lees stated that it was time for investment firms to be more disciplined in segmenting their product offerings and to be more honest about their purpose for funds. Lees suggested that they should focus on companies that provide sustainable solutions rather than companies that try to adapt to an ESG system.
ESG used to be on the other side of asset selection. He said that ESG is becoming more integrated and it’s time for investors and asset allocators to be more clear about their approach and what they bring to this table.
This story was created in partnership with BNP paribas Asset Management.
ESG, paris agreement. UN Principles for Responsible Investment. ESG scores. United Nations Climate Change Conference. Joe Biden’s Infrastructure Bill. Institutional Investors Group on Climate Change. Taxonomy of the European Union.