Responsible Investing Around the World

By: Edris Alrafi

It seems everyone in the asset management industry is talking about responsible investing and the importance of ESG (environmental, social and governance) issues. This was the case prior to the Covid-19 pandemic and now, these global factors are more important than ever.

In the Middle East, this interest is heightened by ESG’s alignment to the economic and strategic visions of many GCC countries that include a strong focus on sustainability, diversification and environmentally friendly practices. These, in turn, result in ongoing regulatory efforts to create standards and frameworks to ensure mandatory sustainability reporting.

Around the world, different regions have embraced ESG principles in varying ways and each market has something to contribute, which is why it is crucial for MENA based investors to have an overview of how ESG is evolving from a global perspective.

Europe: Europe, and more specifically Scandinavia, leads the way as it has had a long and deep relationship with ESG analysis over the past three decades.

One of the most influential managers in Europe is Norges Bank Investment Management, Norway’s sovereign wealth fund, said to be the largest in the world*. It excludes companies that don’t meet guidelines set by Norway’s Government Pension Fund Global. Divestment recommendations are made by a Council of Ethics, which is appointed by Norway’s Ministry of Finance. Decisions are often followed by other Scandinavian and European public pension funds.

In France, ISR (l’Investissement Socialement Responsable), has been dominated by social issues. This reflects the country’s concerns for labour and the environment. For example, Duty of Vigilance 2017 requires companies to have proper oversight of their operations and supply chains. Companies must comply with health, safety, environmental and human rights obligations.

By contrast, other parts of Europe such as Germany, Italy and Switzerland, have been slower to embrace ESG integration.

Emerging markets: Within the global emerging markets, ESG integration has mostly been a tale of catch-up over the past 20 years. The reasons for slower ESG developments are relatively straight-forward but multi-faceted and vary on a country-by-country basis.

In general, the biggest barrier for foreign institutional investors has been language as many companies do not translate the ESG-related information they do provide into English. A second hindrance has been an inadequate supervisory structure or organisation within these markets and a lack of appropriate infrastructure has also taken its toll in terms of government control and regulation.

Better ESG standards require continued evolution in the minds of investors which will, in turn, shape their expectations of the companies in which they invest. We see evidence of that taking place as governments and leading companies see the light.

Carbon footprint, human rights and diversity are emerging as big themes that will encourage a basic box-ticking exercise to meet minimum standards. However, this should evolve into a more in-depth and granular analysis as the conversation between companies and investors progresses.

Asia: Asian companies have been slower than their global counterparts to integrate ESG concepts into their business strategies. But there are signs that this is changing for the better.

Asset owners and asset managers are showing more interest and putting pressure on companies. For example, Japan’s Government Pension Investment Fund (GPIF) announced its intention to increase allocations in ESG-related investments to 10% from 3%. This amount is worth some US$29 billion, sufficient to influence corporate behaviour. Meanwhile, Fund managers have been signing up to internationally recognised agreements.

So, what does all this mean? In general, ESG analysis has evolved beyond screening. The market has moved towards looking at the broader medium- and long-term ESG risks and opportunities associated with assets. At its heart, the analysis is about understanding all aspects of an investment and being an active owner once invested.

Irrespective of the country, we have found that asset owners and managers are critical agents of change. Fund managers around the world have been keen to demonstrate their commitment to ESG tenets.

In the first quarter of 2020, the coronavirus emergency prompted the most severe stock-market crash since the global financial crisis. However, funds that adopt some form of ESG strategy have, by and large, outperformed traditional funds over the past five years.

We should be cautious in making any claims about this short-term performance, but where ESG funds should demonstrate their potential more significantly is once the first phase of the economic recovery is complete. As many have noted, in the medium term, there is an opportunity to ‘build back better’ – establishing a cleaner and greener economy that is ultimately more sustainable.

ESG integration is now part of the mainstream. And, while we see different levels of engagement across countries, we do see a commitment towards helping the world tackle its problems. As we saw with coronavirus, those companies with good ESG characteristics have been among the most robust in times of market upheaval. These businesses will no doubt be in the vanguard of efforts to build a better and more sustainable future.

As for investors looking to do their part while securing their financial futures, impact investing remains a compelling option. We believe this type of investing – and others like it – will only grow in the coming years.

The writer is: Edris Alrafi, Head of Middle East & Africa at Aberdeen Standard Investments

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