Is sustainable investing ready to go mainstream? Stephen Freedman, of UBS, thinks so.
Freedman, an American raised in Geneva, is an investment strategist and lead author of the bank’s newest guide to sustainable wealth creation, “Adding Value(s) to Investing.” If he is right about this strategy, then the title is not merely a play on words because thinking sustainably about investing will actually give those investors a profitable edge others aren’t exploiting.
A Three Pillared Approach
With “Adding Value(s)” UBS and Freedman want to educate client advisors and investors, and encourage more of them to adopt sustainable investing approaches. One of the things they’ve done, therefore, is to describe a wide array of tactics and factors as just three approaches—exclusion, integration and impact.
While these approaches can be followed independently or in conjunction with one another, they can also be seen as levels of sophistication in using one’s values to shape investment decisions and, ultimately, creating positive externalities.
It’s taken decades for the financial industry to get to this level of sophistication, and “Adding Value(s)” includes a simple yet instructive chart following that history from early exclusion approaches in the 1920s through share-holder activism of the 1980s and, finally, impact investing and integration in the 1990s. Freedman’s work in this area has also evolved. Having earned a Ph.D. in financial economics from the University of St. Gallen he became an investment strategist at the bank. That post found him in charge of thematic research for the US Wealth Management division, and sustainable investing emerged out of that research in early 2014, he explained. “It happened to coincide with UBS dedicating a lot more resources to these approaches anticipating growth,” he said.
On the simplistic end of the spectrum exclusion, or negative screening, has a long track record. This approach simply screens out investments that do not fit a particular set of values. That might mean ignoring stocks in alcohol and tobacco, or bonds from countries that do not meet human rights standards, for example. This approach is by far the most widely used, “but it’s not where the action is right now,” according to Freedman.
“Where things get more interesting,” he says, “is with Integration. Integration systematically combines traditional financial analysis with environmental, social and governance (ESG) considerations.”
A relatively common approach to integration, according to Freedman, is positive screening. So where negative screening rejects stocks for having certain traits, positive screening actively looks for investments with positive traits. This “best-in-class” approach relies on published ESG and financial performance ratings.
Beyond positive screening some investors will seek to incorporate ESG risks and opportunities directly into traditional security valuation such as earnings, for example. In such a case so-called ESG integration might include analysis of a security’s earnings potential based on exposure to reputational risk for governance (corruption) issues or, on the other side, potential for market expansion of environmentally sustainable product offerings.
“The most advanced version of ESG integration involves understanding growth prospects for a company and the risks associated, and trying to figure out how any ESG factor will affect those,” says Freedman. “It’s smart because you are factoring in information that others aren’t, and it’s material information, not just noise.”
The third pillar is impact investing. It differs from the other approaches in that it demands positive social or environmental impacts alongside financial gains. Examples noted in “Adding Value(s)” include community investing, microfinance and private equity type investing in education, healthcare, infrastructure and clean energy.
What’s the catch?
That all sounds pretty reasonable but, what I want to know is, if sustainable investing has the potential to give its practitioners an edge, why is it still a relatively obscure niche?
“We need to dispel the myth that you will be leaving money on the table,” answers Freedman. “In fact,” he says, “there is decades of research showing there’s no systematic difference in performance between sustainable and traditional investing approaches.”
“There is a global trend toward more awareness that is affecting companies, consumers and the ability of companies to attract talent. This is not something that is explosive, but a gradual growth,” says Freedman. The idealistic Millennial generation is likely to become an important driver as they age, but polls already show a majority of people accept sustainability principles. A 2014 Nielson survey across 60 countries found 55 percent are willing to pay extra for sustainable products and 67 percent prefer to work for a socially responsible company. Along with wider understanding of climate change, environmental stewardship and social justice have now taken root as basic values among the general public. This fact is ref lected in the United Nations Principles for Responsible Investment, which has nearly 1 400 financial institutions on board, as well as the UN Global Compact and its 8 000 corporate members.
Freedman’s report is definitive in its assessment of these inf luences, stating, “The key is that whether through stakeholder demands or government rules, these trends are affecting the operating environment for companies, who now ignore such considerations at their own risk.”
If investing is about strategising the best way to fulfil some future desire then investors who choose this route, Freedman says, do so with three common desires in mind. One is to align portfolio content with personal values. Another is the desire to have a positive impact on society or the environment. The third is the desire to be the smartest strategist by focusing on companies that are well-positioned to take advantage of opportunities or have a better risk profile. And it seems, according to the report, that this category of investor is growing faster than the traditional type. Sustainable investing is no longer on the fringe.
“It is something that is happening anyway,” says Freedman. “If we talk in 10 years this will not be niche anymore. It will be mainstream thinking.” “Adding Value(s) to Investing” is available from the UBS website. Additional reports are in the works to examine various aspects of sustainable investing in greater detail.
Article by Peter Carson