In this final extract from ‘Beyond the shadow of quantitative easing’, BNP Paribas Investment Partners’ informative overview of the investment outlook for 2017, Jacky Prudhomme, Head of ESG integration, and Gaëtan Obert, Head of Sustainable Thematic Equity & ESG coordinator, argue that ESG considerations should be integral to designing and implementing resilient, future-proof portfolios both on a medium and long-term investment horizon.
Making sense of ESG investments
An ESG approach to investment finds its basis in investigating ESG practices and points of contention and incorporating the results into a broader range of criteria. It thus gives investors more tools when they assess the level of risk they want to take. Having an in-depth knowledge of the ESG dimensions of a company can improve the comprehension of that company’s strengths and weaknesses.
ESG is also about protecting investors from reputational and operational risk. Applying minimum ESG requirements is about ensuring, first of all, that you are not exposed to companies that are more likely to be involved in significant ESG-related issues such as human rights abuses or causing significant environmental damage. Besides the reputational element, such issues could have a major adverse effect on financial performance.
The ESG approach can be plugged into investors’ toolkits to help provide better forecasts of the risks and soundness of security issuers eligible for investment. Researching issues associated with ESG can help to generate value for investors, particularly those pursuing longer-term objectives, by mitigating risk and focusing attention on better-quality, more resilient companies. This can help to unlock upside potential and enlarge the scope of investments. For example, including ESG-friendly technologies such as renewable energy or energy efficiency can have significant potential and should be of considerable interest to investors.
In a low-growth, low-yield environment, should ESG principles take a back seat?
Since the 2008 crisis, it has become clear that ESG-oriented practices can help to mitigate risk. Investors are recognising the value of integrating an ESG dimension and have become more comfortable with ESG. For many fund managers, it is now part of their investment strategy to look into ESG issues and to find room in their investment models for specific ESG criteria.
We expect the trend towards ESG integration to continue in 2017, both at the investor level – including investment managers and other asset owners – and at the issuer level where more forward-looking companies and other security issuers are making a virtue of exhibiting ESG-based values. Increasingly, an ESG approach is becoming a must-have for many businesses.
The future of ESG
Increased responsibility reflects the challenges faced by many modern societies, from climate change to a scarcity of resources, to malnutrition and obesity, access to (affordable) medicine and social tensions. At the regional level, Europe already has many stringent regulations in terms of environmental protection and social standards, so if as an investor you want to incorporate limited ESG risk into your portfolio, you would likely favour European companies over Asian or North American companies.
That may change over the medium term. China has been changing its stance on environmental protection and is now addressing the health problems related to poor air and water quality. However, many developing economies are still lagging, not only on addressing environmental issues, but also labour practices and human rights.
At an asset class level, it is becoming increasingly important to have a clear understanding of the value chains of the companies we invest in and to assess the social standards applied by their contractors and sub-contractors. ESG analysis is being widened to include the sphere of responsibility of the company and its ability to impose its best practices on those it interacts with. The pressure is coming both from investors who are engaging with companies and seeking greater disclosure and from regulators who are demanding companies investigate their value chains and social risk.
The pressure for improvements in such areas should continue unabated. Stakeholder activism in ESG areas ranging from corporate governance to business ethics and business practices, addressing issues including anticompetitive practices, bribery, corruption and tax evasion, is unlikely to let up.
For investors with a keen focus both on the rewards from investments and on managing the risks, the role of ESG investing in making a portfolio future-proof is compelling.
This article was written by Gaëtan Obert and Jacky Prudhomme.