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2020 – A turning point for ESG investing

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Gabriel WILSON OTTO
 

In many ways, 2020 was a turning point. One key area within environmental, social and governance (ESG) investing was putting a spotlight on corporate behaviour and what constitutes business resilience.

There was a greater focus on how companies are treating their customers and employees in the context of a heightened awareness and appreciation of the environment in which they operate. The underlying cause was of course the pandemic which led to greater sensitivity to vulnerabilities and weaknesses in a range of systems that went beyond healthcare and raised questions about our world’s resilience to shocks, including the resilience of companies.

This brought with it a tailwind for issues around ESG criteria and the need for more financing to address these issues. At the start of 2020, we saw a pivot from green financing towards social bonds, which saw record issuance in 2020.

As the year progressed, substantial longer-term green funding commitments emerged. This was driven by a desire to ‘build back better’ in a post-pandemic world. It is reflected in the huge interest in supporting a broader energy transition.

This trend received a boost from a raft of additional commitments including the setting of firm targets for net zero emissions of greenhouse gases in the next few decades, including China, Japan and South Korea. In my view, this had the potential to be a game changer both in terms of the impact on the environment, but also more broadly with regard to the investment themes this wave of investments can support.

2020 – An expansion of the ESG opportunity set

Events in 2020 will have major consequences for ESG investing both in terms of asset classes and sectors.

Firstly with regards to asset classes, we have seen a huge commitment to the funding of infrastructure projects. This is going to turbocharge green bond issuance and green finance more broadly. We expect record issuance this year and strong issuance in the future to fund these projects. So this should be an area of focus for investors.

Secondly, when we think about ESG integration in equity markets, there are two key ways of getting exposure:

  1. Risk management – Evaluating how resilient your business is. COVID-19 has shown us that some business practices and assets, previously considered robust, proved to be more volatile than anticipated. ESG analysis can really help investors with risk evaluation and accurately assessing risk exposure.
  2. The other side to thinking about exposures is around the themes where for many observers, there is considerable upside potential. In 2020, the renewable energy sector outperformed very significantly. Major commitments were made to build green financing projects and on net-zero commitments. I would expect renewable energy to benefit from a multi-year tailwind. I expect the UN Biodiversity conference in China in May to lead to greater interest in ecosystem restoration/preservation as well as broader environmental protection. Other themes we believe investors should have on their radar include environmental services (waste, recycling, and water treatment) and financial inclusion (payment platforms, access to financing/credit).

Of course, the challenge for investors is picking investments that are actually ‘green’. We believe the integration of ESG criteria in the security selection process is key to being able to assess and manage risk and determine how resilient a company is and how much potential upside it has. This is a case of better insight into a business leading to better investment decisions.

Consolidating ESG investing

In that sense, 2020 has reinforced and consolidated our view that an ESG assessment provides essential information on how successful and resilient a company – or another issuer of securities – can be in the longer term.

Admittedly, issues around defining ESG remain, but 2020 saw an acceleration in the trend towards greater transparency and harmonisation on the underlying criteria. There is still work to be done.

To illustrate the point, when rating agencies conduct conventional risk analysis of sovereign bonds, there is a strong, almost perfect, correlation between the assessments from the different agencies. When it comes to ESG ratings, the results are much more diverse. This is partly due to different focuses on what constitutes ESG and the risks it poses for financial performance, but also the choice of data used and the quality of the data.

Continuing the work on data quality and transparent reporting

That is why, at BNP Paribas Asset Management, we have set up our own ESG scoring system to ensure consistency and transparency across our offering. In the context of an exploding interest in ESG, we believe there is a great need for clarification, harmonisation, regulation and standardisation.

So, ‘to walk the talk,’ we are participating in many bodies and committees working on improvements in this area. An example is our contribution to work commissioned by the European Commission on a taxonomy, or classification, defining which activities are sustainable and under which circumstances. We have welcomed, and are contributing, to efforts by regulators to enhance the quality of both ESG data and broader reporting by issuers and asset managers.

Conclusion

The pandemic has led to greater awareness of ESG issues, both in life generally and in business. This has reinforced the case for investing from an ESG perspective.

For an investor, this is attractive because it is a way of doing good. Financially, we believe it can be rewarding as we are convinced that ESG investing is directly compatible with higher risk-adjusted returns.

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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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