ESG: no easy road for asset managers

Annemarie Arens headshot
Annemarie Arens, whose career in Luxembourg’s finance industry spans four decades, offers answers to some critical questions.

Asset managers must adapt to a new landscape where ESG factors play a growing role in their approach to strategies, and leading to difficult decisions of either support or divestment. Yet, how do they make those decisions? How will they change in the years ahead? And whatever happened to the ‘S’ in ESG?

Annemarie Arens, an independent director at various financial companies as well as the Nurturing Dignity Foundation – and the former General Manager of sustainable finance labelling agency, LuxFLAG – helps us find answers to these questions and more.

For a growing number of clients, deciding whether to invest in Environmental, Social and Governance funds falls squarely into the category of the ‘no-brainer.’ After all, who doesn’t want a healthy return while saving the planet and making the world a better place?

For asset managers, though, ESG is not so simple.

From an assessment process seen by some as opaque, inadequate or both to a set of acceptable outcomes ranging from significant profits to small losses, ESG’s landscape is complex to navigate. For Annemarie Arens, who has spent nearly 35 years in Luxembourg’s finance industry, ESG brings the asset management community a formidable series of challenges, as well as opportunities.

Joining the ESG bandwagon

The first of those challenges? Drop any remaining doubts about ESG and start swimming with the tide.

“It was always a myth that ESG had a negative influence on performance,” she told VitalBriefing, “and today the carbon footprint of a corporation has become a very strong argument when it comes to the investment universe.

Asset managers who are unwilling to step in to the ESG area will have a long-term viability issue because if you can’t demonstrate a very serious process around ESG and sustainable finance, you’ll definitely never win a mandate, or be allocated a portfolio by an insurance company.”

It’s a stark warning, and one she quickly follows with another: finding the data to make an informed assessment of true ESG compliance is something of a Holy Grail — one which only leads to more difficult decisions.

“Today, you cannot compare one ESG product with another because there is hardly enough comprehensive, accurate and granular data available,” Arens says. “Also, to make a proper assessment, you need to look at the ESG factors not only of the company, but also its suppliers and the rest of its value chain. But this isn’t always done, either by internal research departments or by external ratings agencies.”

A tough judgement call

And even when a reasonable amount of data is available, an ESG investment decision is not just about current numbers or easy calculations.

What’s the call on a listed company that has positive scores on eight out of 10 ESG criteria, but fails on two? Divest? Stay?

Typically, asset managers decide on the basis of what Arens calls ‘soft information,’ which means meeting the firm’s executives and understanding where their ambitions lie, talking to employees and looking closely at their commitment to Corporate Social Responsibility.

In short, it’s about finding out the company’s “direction of travel” — with the automobile industry offering an apt example of the complexity of (and subjectivity involved in) reaching a final decision.

Petrol and diesel cars play an indisputable and massive role in climate change, pollution and poor health among urban populations. So, there’s scope for righteous indignation and a clear case for disinvesting on ESG grounds.

But as Arens points out: “We’re trying to replace an industry that’s been going for more than a century with electric cars. We have to accept that it takes time to rebalance entire industrial sectors to make them more sustainable, and that it’s often better to contribute financially to a company that is heading in the right direction than to pull out.”

Improving the regulatory environment

Negatives aside, Arens believes that ESG assessments will improve — notably with the Sustainability Technical Standards, which aim to standardise reporting of ESG data, and the EU Taxonomy on sustainable finance, which sets out the categories and thresholds for sustainable activities.

Together, they aim to bring more clarity and consistency to the ESG process.

In addition, shareholder rights are now exercised in a far more muscular way, particularly when it comes to transparency, the proper governance of executive pay and a company’s long-term sustainability. It’s a significant change over the last five years, encouraged by regulators who want to see more independent directors on boards.

In the meantime, for investors committed to global change there’s only one real option: Impact Investing, which supports projects that make a positive impact on issues such as poverty, malnutrition, disease and environmental damage, with the fund return relegated to secondary importance.

“Impact Investing is the real driver for change,” Arens says. “It’s much easier to understand, because you know exactly what you’re buying. It’s not like the current problem with ESG products, where you don’t know how much of it is ESG and how much is negative, because the impact here is always positive.”

Typically offered with returns of around 3% over seven or nine years, they also attract investors willing to take the ‘first loss’ if the fund suffers a downturn.

The missing letter

Impact Investing is also available in a more extreme form — Inclusive Investing — which supports similar projects but aims at best to return the initial investment, and is effectively appropriate for the philanthropically inclined.

Together, they compensate for an element sadly all too often absent from ESG ambitions: namely, the letter ‘S’. While protecting the environment and tackling scandals of corporate governance are front and centre, action on social criteria are frequently missing.

“For almost every ESG product, the E and the G are always in capital letters, whereas the S is very often forgotten in the entire process,” Arens laments, pointing to an inclination ingrained from childhood of putting self-interest first.

“Society in Europe and America has a strong influence on people’s thinking and mindsets, and the egoism you experience while growing up, in education, and in your professional life, all influences you, and it plays into your view of social aspects.”

Industry with a mission

Despite the shortcomings, there is reason to believe that ESG funds will help the finance industry make a contribution to resolving the world’s biggest challenges, namely the UN Sustainable Development Goals (SDGs).

Arens, for one, believes that Impact Investing will make the biggest contribution to achieving the key SDGs, such as tackling poverty and hunger, and that even more could be done if, for example, every financial product or fund could be obliged to help realise at least one of the UN’s 17 goals.

However, experience has also taught her not to moderate her hopes and expectations.

“Unfortunately, people look for alternatives if returns are not what they expect. If you look at the development of the finance industry, products have always been created to avoid certain things, like taxes in the past, and tomorrow it might be contributions to ESG and the SDGs.

“I can only hope that won’t happen and that the industry contributes to the SDGs, climate finance and social impacts, and that we don’t fall back to it being all about money.”

We hope you found this article useful. It is part of our Sustainability Matters interview series, in which we speak with experts across every facet of sustainability, ESG, sustainable financeimpact investing and more. Stay tuned for more insight from thought leaders. In the meantime, enjoy other, related interviews:

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