From solely wealth creation to wealth creation and wellbeing
It’s an investment sector that’s yet to be fully realised and is widely misunderstood. But for those looking to capitalise on the merits of sustainable investing, applying the various dimensions of sustainability to credit portfolios – and excluding some of the most controversial companies in the selection process – can significantly contribute to reducing downside risks in these credit portfolios as well.
Launched in 2015 and often used as the basis for impact investing, the United Nation’s (UN’s) Sustainable Development Goals (SDGs) take the quest for sustainability to the next level by making integration tangible and measurable.
In recent years, it’s become increasingly apparent that incorporating sustainable investing (SI) into an investment strategy doesn’t detract from performance. In contrast, professional investors intentionally seek to leverage SI and the payoff is two-fold; not only are they likely to benefit financially, but the ability to give to the greater good is also a driving force.
Investors are increasingly looking to create more sustainable portfolios. The natural consequence of moving from an exercise of pure financial gain to one that equally recognises non-monetary gains is leading to the emergence of a new investment industry – it’s an industry that has evolved from wealth creation, to one of wealth creation and well-being. And the UN’s SDGs are fundamental to this shift.
Investors are becoming increasingly interested in investment products that contribute to the realisation of these goals and at the same time offer attractive returns. But with 17 goals and 169 targets – such as the elimination of poverty and hunger, decent work and growth, sustainable cities and communities – the SDGs address a very broad range of issues, some of which have conflicting impacts on each other.
HOW TO INTRODUCE AN SDG ASSESSMENT FRAMEWORK?
There are many intuitive reasons why it’s essential to incorporate SDG considerations into investment strategies. In an increasingly renewables-powered global economy, it is easy to foresee that the business models of companies such as coal miners, oil producers and fossil fuel-based electricity generators will come under severe pressure. Although less obvious, the same applies to car manufacturers that do not adapt quickly enough to a world of electric vehicles.
The financial consequences – in the form of fines, compensation and potential license withdrawals – can be very material for companies that fail to act in accordance with the SDGs. Environmental spills, bribery, money laundering and mis-selling are a few examples. Ignoring the SDGs could therefore ultimately affect every investor, reinforcing the relevance of SDG-linked investment strategies.
The UN Commission on Trade and Development (UNCTAD) estimates that between US$5 – 7 trillion per year will be needed to achieve these goals within the desired timescale. As governments alone are unlikely to be able to find such huge sums of money, the UN has explicitly asked the private sector, including asset owners, to contribute as well. According to a survey among Dutch institutional investors carried out by the Dutch Association of Investors for Sustainable Development, SDGs are on the agenda of pension fund boards, although most of them have yet to integrate SDGs into their portfolios.
Using clear, objective and consistent guidelines it is possible to deal with some of the challenges faced by screening companies for their SDG preparedness. These guidelines include analysis of:
- What do companies produce? The first step links the products and services offered by companies to the SDGs and assesses to what extent they contribute to or detract from them.
- How do companies produce? The second step is about how a company operates. Does it cause pollution, respect labour rights, respect the rule of law and have a diversified management?
- Are there any controversies? A company can meet the criteria outlined in these first two steps by making the right products and operating in the right manner but still be caught up in controversies such as oil spills, fraud or bribery. In this context, it is important to know if the controversy is structural or just a one-off, and whether the management has taken sufficient precautions to prevent recurrence in the foreseeable future.
Then, based on this information, a credit portfolio can be created that not only makes a positive contribution to the UN SDGs but also delivers attractive financial returns.
But the fact that a credit has made it through the SDG screening is never the only reason to invest in it. A fundamental credit analysis should be conducted, and a position only taken if it offers attractive valuations relative to its fundamentals.
As an example, Robeco’s Credits team has applied its SDG framework to a credit universe of over 600 names. The overall outcome was that 60 per cent of the companies were assessed as making a positive contribution to the SDGs; 24 per cent of companies received a negative SDG score; and 16 per cent received a neutral ranking. In 10 per cent of cases, the scores were adjusted in steps two and three.
SECTOR SDG PROFILES
It’s difficult to approach SDGs purely through sectors. Nevertheless, based on the framework analysis applied, grid operators and companies in the banking, healthcare, utility and communications sectors generally have a strong SDG profile, while companies in the food and beverage, automotive and energy sectors generally have a weaker one.
The weaker SDG profile of companies in the food and beverage sector might seem somewhat surprising. Intuitively, one would expect the food and beverage sector as a whole to contribute significantly to SDG Two (Zero Hunger). Unfortunately, however, the opposite turns out to be the case. Both SDG Two and SDG Three (Good Health and Wellbeing) require healthy and nutritious food. And herein lies the problem. Most food and beverage producers add too much sugar and/or fat to their products. The result is unhealthy high-calorie foods that are helping fuel the global obesity epidemic. More and more food manufacturers are adapting their product palette to tackle this, but the proportion of healthy foods they produce is generally still far below the thresholds defined in our SDG framework.
Another challenging industry from an SDG perspective is the energy sector. In our SDG framework both the E&P (exploration and production) and oil services (oilfield services and refining) industries are assessed as negative. We currently categorise natural gas as an ‘intermediate’ energy source and believe it could facilitate the transition to a global economy based entirely on renewable sources of energy. Those E&P companies at which over 65 per cent of production consists of natural gas actually receive a positive-low impact SDG score, while those with 45 per cent receive a neutral impact score. An additional requirement is that companies in this industry should not engage in fracking.
Unfortunately, there are very few companies that are able to achieve these thresholds. Other sectors that generally do not do particularly well in the SDG assessment are the aerospace, defense, tobacco, and gaming industries. Sectors that have a more positive impact from an SDG perspective include telecoms, banks, grid operators, and healthcare/pharmaceutical companies.
So, while it is easy for asset managers to talk about sustainability, it is much more challenging for them to implement it. Compounding the lack of a clear definition is the challenge of measuring the impact sustainable investors make.
Nevertheless, it is clear that applying various dimensions of sustainability to credit portfolios – including exclusion, ESG integration, engagement, environmental footprint reduction, green bonds and alignment with the UN SDGs – and using financially-material ESG information, will lead to better-informed investment decisions with the added bonus of providing benefits to society.
Guido Moret is head of sustainability integration credits at Robeco
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