Maria Nazarova-Doyle, head of Pension Investments and Responsible Investments at Scottish Widows, explains how ESG investing within multi-asset portfolios, requires a different approach to traditional investment decision-making.
Global sustainability challenges, such as climate change, data security, inequality, modern slavery and regulatory pressures, are introducing new risk factors for investors. In response, investors have been re-evaluating traditional investment approaches.
As such, we employ a responsible investment approach which focuses on managing ESG risks and minimising harm that investments can bring about, while looking to take advantage of ESG-related opportunities and improve real economy outcomes where possible. ESG is shorthand for a decision-making framework that considers environmental, social and governance factors. This is an evolution of traditional financial analysis techniques used to build a portfolio of investments. It’s based on the belief that better investment decisions and better investment performance will come from evaluating wider risks and opportunities affecting businesses, which includes ESG risks and opportunities. Recognising and understanding ESG factors can enhance investment risk management and enhance knowledge of the potential opportunities available.
We integrate ESG considerations into our multi-asset funds because it’s clear they have a financial impact on investments. Companies failing to address ESG issues are likely to see growth severely limited by future regulation, they could be hit with large fines impacting profits and reputations, and they run the risk of becoming out-of-favour with consumers and investors, leading to falls in their value. As well as avoiding the risks, we look to focus on the opportunities, for example companies successfully managing the transition to a low-carbon economy.
So we’re investing where we can in companies we believe are making a difference on ESG grounds, and working with other companies we invest in to help them evolve into more sustainable businesses. We’re also excluding companies which we believe pose too much of an investment risk due to the nature of their businesses.
Our responsible investment approach is four-fold:
2. Screening and divestment
We prefer to have a constructive dialogue with the senior management of companies we invest in where we believe they need to improve their ESG performance. If we simply exclude companies from our investment portfolios, we lose the opportunity to drive positive change by exerting an influence on them. But there are some companies involved in activities that have such a negative impact on the planet and society that they risk falling out of favour with investors and consumers, leading to falls in their value and so pose an unacceptable investment risk. Due to the nature of their businesses, or the nature of our investments in them, we believe engagement would make no difference to their long-term prospects, or is not appropriate, and we exclude them. Exclusions in our multi-asset funds include companies involved in thermal coal and tar sands, manufacturers of controversial weapons and violators of international standards on human rights, labour, environment and corruption, known as the UN Global Compact.
2. Integration
We look at economic scenarios which take into account the impact of climate risk and other ESG factors on longer-term asset class projections and use this to help set the Strategic Asset Allocation for our multi-asset funds. Climate change is one of the biggest issues facing society today and we believe reducing the carbon footprint of our investments has the potential to deliver long-term positive investment outcomes given the stance of regulators, governments and investors alike. So we’re aiming to halve the carbon footprint of our investments by 2030 on our path to a carbon neutral position by 2050. The remainder that still have a positive carbon footprint will have a plan to finish transitioning, and to offset these residual emissions, we’ll be increasing investment in climate solutions such as renewable energy, low carbon buildings and energy efficient technologies.
3. Allocation
Our multi-asset funds are invested predominantly in third party single asset class funds so our strategic asset allocation optimisation gives us the opportunity to increasingly invest in ESG investment strategies.
To do this, we’re working with our appointed investment managers to develop climate-aware investment funds which have a bias towards investing in companies that are adapting their businesses to be less carbon-intensive or developing climate solutions, such as renewable energy, sustainable agriculture and pollution prevention. We’ve already invested 20% of the equities portion of our Pension Portfolio Funds and Retirement Portfolio Funds in a climate transition fund which we developed with our appointed investment manager BlackRock. We’re also investing a portion of the global bond allocations in a new ESG low-carbon global bond fund which BlackRock designed in consultation with Scottish Widows. From November 24th 2022, the property fund we invest in will track a new green low carbon index tilted towards companies making improvements in green building certification, energy usage and carbon emissions intensity.
4. Active stewardship
We take our role as active stewards of customers’ pension savings seriously and this is reflected in us becoming one of the first signatories to the new Stewardship Code. We don’t believe it’s good enough to leave this crucial activity only to the fund managers we’ve appointed to manage our investments. When we’ve a significant investment in a company, such as through our multi-asset funds, and have ESG concerns, we’ll engage with them directly to encourage positive change and we also exercise our voting rights directly on a selective basis for key issues.
Ever evolving
While we believe we’ve made significant progress on ESG integration, we’re continually evolving our approach and we’ll be making further adjustments to the components of our multi-asset funds. For example, we’re working with policymakers and industry peers to explore private market investment opportunities, like infrastructure and nature-based solutions, required to successfully transition to a lower carbon economy whilst also having a positive social and environmental impact.
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