now loading...
Wealth Asia Connect Middle East Treasury & Capital Markets Europe ESG Forum TechTalk
ESG Investing
Investing for sustainability impact will transform capital allocation
Bottom-up, rather than top-down, dynamic set to power unfolding ESG revolution in coming years
Jonathan Rogers 2 Aug 2021

Swimming through the acronym-laden waters of the environmental, social and governance (ESG) landscape involves an often irritating thrash through that overwhelming thick alphabet soup, but it behoves anyone with a vested interest in the topic to become effortlessly familiar with all the letters and what they stand for.

The latest to rise to the surface is IFSI – investing for sustainability impact. At first glance, this acronym might seem like another term that describes ESG. But not so fast. When you break it down into the two constituent parts that make it up – instrumental IFSI and ultimate ends IFSI – you uncover the components of a dynamic that seems likely to power the unfolding ESG revolution in the coming years.

This dynamic will be driven by the behaviour of investors and the attendant impact of this behaviour on companies and government policy-making. In simple terms, this dynamic is bottom-up rather than top-down. There are two motivations within IFSI. One is the targeting by an investor of sustainability goals in order to realize financial returns. This is instrumental IFSI.

The other, ultimate ends IFSI, involves directly pursuing an impact goal driven by overarching sustainability outcomes – for example, perhaps meeting the Paris agreement climate targets or the United Nations’ Sustainable Development Goals – and doing so, alongside the investor’s financial return aims, but not entirely as a means to achieving them.

A report recently published by Freshfields Bruckhaus Deringer and launched under the auspices of the Principles for Responsible Investment, the United Nations Environment Programme Finance Initiative and the Generation Foundation sets the stage for what one of the report’s authors, David Rouch, describes as a “paradigm shift” in sustainable investing.

The report examines the legal backdrop for IFSI across a range of jurisdictions and, within the two most important investor categories – asset owners, comprising pension funds, mutual funds and insurance companies, and investment managers – observes that “the bulk of global institutional investor assets under management (AUM), approximately US$110 trillion, does not appear to involve IFSI”. But this is set to change as the ESG juggernaut rolls along at breakneck speed.

“More purposeful investing is what many individual investors want from those who manage their assets,” suggests the report, something which will involve investors intentionally using their powers to effect assessable behavioural changes within business enterprises or among policy-makers according to sustainability impact goals.

A range of tools exist for investors to exert assessable IFSI impact on investee enterprises ­– such as introducing shareholder resolutions, voting at annual general meeting, and actively engaging in dialogue with management – with such engagement increasingly regarded as a key component of their fiduciary duty.

In all this, it would be tempting to reduce the scenario to a “culture clash” between the short-termism, typified by an investment style that focuses on quarterly or semi-annual financial metrics, beating benchmark indices, and generating financial alpha with high levels of portfolio turnover, versus a longer-term modus operandi, exemplified by passive investing of which the best exemplar is the index fund.

Asset management leviathan BlackRock highlights this behavioural divergence in the Freshfields Bruckhaus Deringer report: “In managing our index funds... BlackRock cannot express its disapproval by selling the company’s securities as long as that company remains in the relevant index. As a result, our responsibility to engage and vote is more important than ever. In this sense, index investors are the ultimate long-term investors, providing patient capital for companies to grow and prosper.”

And passive investing is growing as an investment style, and one which might seem a misnomer in relation to IFSI, because, as explained by BlackRock, it in no way precludes active investor engagement with investee companies. Passive investing has been steadily growing as an investment strategy, and two years ago stood at 21% of all global AUM (US$18 trillion). With the growth of ESG benchmark indices – such as the recently launched Climate Action 100+ initiative, the net-zero company benchmark – the prospect of IFSI being facilitated via passive investment strategies looms large.

IFSI will also be powered by investor coalitions, such as the NetZero Asset Managers Initiative and the Net-Zero Asset Owners Alliance, whose members control respectively US$43 trillion and US$6.6 trillion of AUM. As the Freshfields Bruckhaus Deringer report notes, collective action among investors reduces costs and increases the chances of an auspicious sustainability outcome. “Cooperation of this sort is possible in all jurisdictions,” it states. “And a significant number of collaborative ventures are already underway at both the national and international levels.”

IFSI covers a broader range of investment activities than those that typically fall under the umbrella of impact investing. And its full embrace by the investment community and policy-makers – in the latter case, through the creation of market ecosystems underpinned by the availability of readily comparable data and the strengthening of market discipline to avoid “impact washing” through product labelling, and, in the former, through the consideration of a portfolio’s climate, carbon and biodiversity impact – will initiate fundamental changes to the allocation of investment capital.

“The report will underpin the next steps of the evolution of responsible investment and bring sustainable investing into the mainstream,” says Fiona Reynolds, CEO of the UN-supported Principles for Responsible Investment, a co-sponsor of the report. “It will help create a shift within the investment industry away from the risk-return lens to a greater focus on the impacts investors’ portfolios have on the real world.”

“Ultimate ends IFSI will become an imperative in order for an asset owner or asset manager to achieve their net-zero targets,” says David Blood, co-founder with Al Gore of Generation Investment Management. “They will need to assess the carbon and climate impact of their portfolios, which will cause them to think about how they will allocate capital going forward. It will be in their financial interests as well as their net-zero interests to do so. We are about to transform the way we are allocating capital.”

Conversation
Cynthia Tchikoltsoff
Cynthia Tchikoltsoff
head of supply chain management, Asia Pacific
BNP Paribas
- JOINED THE EVENT -
4th ESG Summit - Webinar series
Rising Expectations
Part 1 - Covid conversation
View Highlights
Conversation
Danielle Welsh-Rose
Danielle Welsh-Rose
head of the Sustainability Institute, APAC, and ESG investment director, Asia Pacific
abrdn
- JOINED THE EVENT -
Webinar
APAC Climate Change Progress & Obstacles in 2022
View Highlights