Richard Brandweiner: sustainable investing explained
What are the different ypes of sustainable investments, how did they develop and why are they growing so quickly? Pendal CEO Richard Brandweiner explains in this Lonsec webinar from June 10, 2020.
Watch the video above or read the transcript below.
RICHARD BRANDWEINER: Sustainability is a particularly relevant topic right now for many reasons.
This is not just because of what we’ve experienced recently through bushfires, floods, famine — and the perspective that the economy is intrinsically linked to these events and our behaviours.
But also because regulators around the world and people are starting to evolve and adapt and change.
Your clients — and yourselves — are starting to buy goods and services based not just on what a company does, but how they go about doing it.
These are fundamental shifts in our psyche that are underpinning a wholesale move towards greater thinking about how we invest.
I’d like to take you on the journey of how we’ve got here and how we’ve evolved in the investment profession from “ethical investing” all the way to “impact investing”.
Then I’ll give you some thoughts about how we at Pendal are adapting to that and have adapted to that over many years.
Then I’ll put that in perspective around the latest development — positive impact.
Ethical investing — where it started
This all really started years ago as ethical funds began to emerge in the 1980s and 1990s.
The idea of “ethical investing” then was very much about values. It was mainly church-based or faith-based groups investing in ways that were aligned with their moral code or their values.
It was really about screening: about not owning tobacco, not owning gaming, not owning other types of companies that do harm.
This movement grew in the first part of the 2000s around the concept of “externalities”.
Externalities is an economic concept that refers to an activity’s second and third-order effects on the broader ecosystem.
It is best illustrated by an economic problem known as “the Tragedy of the Commons”, which was first talked about in the early 19th century by an English economist, William Forster Lloyd.
Lloyd observed that if I graze my cattle on common land, it’s in my interests to put more cattle on the land. But if everyone did that, acting in their own best interests, the external impact was the devastation of the land for everybody.
So there was a conflict between your internal motivations and what’s best for society — and ultimately for you in the long term.
Now we recognise pollution is an externality. We recognise supply chains generate externalities. Even employment generates externalities.
Little by little, as we became more sophisticated, we understood you could measure those externalities — and they weren’t free. The costs were borne by society.
As regulation evolved and as we became more aware of externalities, it became clear they ended up affecting your earnings over time — as regulations shifted or consumer demand changed.
And that ultimately leads to a change in your cost base.
A good friend of mine from asset consultant Willis Towers Watson wrote a wonderful article that said “past performance is not even a good guide to past performance”.
What he means is the performance of stocks and securities over a period of time is not fully reflective of the true, intrinsic earnings of those companies — because they didn’t factor in a lot of the externalities those companies were generating.
A good example is tobacco.
Tobacco was the best-performing sector in the world over the last century. I don’t think that will be the case over the next century. But the reason why it performed so well in the past is that as a society we didn’t understand the externalities.
We didn’t understand the impact of the products being sold. We weren’t factoring that properly into an assessment of the companies.
Environmental, Social and Governance (ESG) factors
So the United Nations principles for Responsible Investments grew and the emphasis on this new idea of ESG — environmental, social and governance criteria — became an idea around long-term risk management.
ESG recognised that if these externalities are real — and if we expect over time they will be increasingly factored into the price of securities — then as investors we should start thinking about these factors now.
It wasn’t about values. It wasn’t about what you believe is right or is wrong. This evolution from ethical investing to ESG was in its early incarnation about long-term risk management of making an investment decision.
Then things evolved another step.
We recognised these externalities — these second and third-order impacts — were real. And as investors we recognised the potential to build portfolios in a way that was more sustainable and recognised the impact of these externalities.
We could build a “sustainable portfolio” that not only managed ESG risks and factored them into the pricing of securities. It could also bias a portfolio towards more sustainable companies or sectors over time.
Why might you do that? There are two reasons.
You might believe there’s an alpha source there. You might believe those sorts of companies will perform better over time.
As consumer behaviour changes, they’ll be more attracted to products and companies that are sustainable. Companies that are less sustainable will actually do worse over time.
The other reason is because you want your capital to be invested in positive ways.
This is happening more and more. Sustainable investing is one of the fastest-growing parts of the investment management universe.
About nine out of 10 Australians in recent Roy Morgan research have said they expect their investments to be managed in a sustainable way.
That is something we really can’t ignore.
But there’s a final step to this — and that is impact investing.
Impact investing not only recognises those externalities, it deliberately builds a portfolio targeting the creation of positive externalities.
It’s not simply asking: “is this a sustainable company in a sustainable industry?” It’s recognising a company can generate very positive and profound outcomes for the world.
Impact investing is about targeting those sorts of investments and then measuring the outcomes beyond the financial returns of the company.
Impact investing is the point of the arrow. This is the bit where we actually recognise that capital has real power and that all of us — financial advisors, fund managers, asset owners — are in a very unique position.
We are in a position of responsibility. A position to operate as fiduciaries recognising the way we invest matters.
There is a purpose to our financial system. The purpose is not money in its own right. It’s not an end in of itself.
The purpose is to channel capital towards productive enterprise and to create our future.
There’s about $130 trillion globally that sits in pension funds, super funds, sovereign wealth funds advised by financial advisors, fund managers, insurance companies. That’s almost twice the value of annual global GDP.
The way that money is invested will help shape the world that your clients and you and me will retire into.
That makes impact investing hugely important for us as fiduciaries, advisors and allocators of capital.
This is about our growth as investors — as humans recognising the world is not two-dimensional. It is a complex, adaptive system.
The third axis
We can think of this as the third axis of investing.
In the beginning there was one axis — returns. Back in the 1940s and 1950s we really only spoke to our clients about the returns we generated.
Then with modern portfolio theory the idea of risk emerged and we had two axes — risk and return.
Today it seems like madness to think about return without understanding the risk we’re taking to get that return. But it was always there — we just didn’t measure it.
Now we realise there is a third axis — the impact of the investment or the company or government we are lending money to.
Again — the third axis was always there. We just didn’t measure it like we are starting to do now.
Pendal and Regnan
We helped found an organisation called Regnan, which is now one of the leading ESG research and engagement providers in Australia.
Regnan’s business originated with work done in conjunction with Monash University in Melbourne in the 1990s to think about the impact of environmental change on company earnings.
Recently, Pendal bought out our other Regnan partners to bring it a lot closer to our investment decision-making.
We’re now using Regnan to grow the impact investing space.
We recently launched a product called the Regnan Credit Impact fund, which lends money to investment-grade borrowers, governments, super nationals and corporates for green and social bonds. Then we measure the outcomes of all that lending.
Even at launch with a small initial seeding of $30 million, the fund is already taking something like 13,000 tons of carbon dioxide out of the atmosphere on an annual basis.
It’s restored 60 hectares of forests.
It’s generated 16,000 megawatts of renewable energy a year.
It’s provided 340 jobs.
It’s created 50 loans to female-owned small enterprises.
And all of that with high-quality, investment grade credit paying strong returns.
So you’re getting liquidity and high-quality, investment-grade credit. And at the same time these externalities are being measured and targeted.
For us, that’s a huge leap.
Pendal sustainable funds
Pendal offers a range of sustainable products across different asset classes. We have been doing this for a long time and they are well-rated.
- Pendal Sustainable Balanced – Est. 1984 – Diversified/Multi-Asset
- Pendal Sustainable Conservative – Est. 1989 – Diversified/Multi-Asset
- Pendal Ethical Share – Est. 2001 – Australian Equities
- Pendal Sustainable Australian Share – Est. 2001 – Australian Equities
- Pendal Sustainable Australian Fixed Interest – Est. 2016 – Australian Fixed Income
- Pendal Sustainable International Fixed Interest – Est. 2016 – International Fixed Income
- Pendal Sustainable International Share – Est. 2016 – International Equities
- Pendal Sustainable Future Australian Shares SMA – Est. 2018 – Australian Equities
This year we are launching high-impact investment strategies globally under our Regnan brand:
- Regnan Credit Impact Trust – Est.2020 – Australian Fixed Income
- Regnan Global Equity Income Solutions – To be launched in late 2020 – Global Equities
Richard Brandweiner is Pendal’s Chief Executive Officer, Australia. Richard has more than 20 years of experience in investment management and is responsible for the Australian arm of Pendal Group, including asset management, operations, sales and marketing.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
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