During her 18 years in investment management, head of unit trust relationships at Legal & General Nancy Kilpatrick has seen her fair share of emerging trends, but the recent surge in Environmental, Social and Governance (ESG) investment strategies has been particularly noteworthy. “Responsible investing has gathered pace quite markedly over the last year or two,” she says. “And, equally, the ESG investment industry has grown enormously, hitting its first $1tn globally last year.”
Kilpatrick says the investment landscape has moved on from purely the exclusionary towards ESG being a more mainstream and a positive contributor in driving change. “Early versions of ESG investing were based purely on ethics and negative screening. Trustees would come at it from the point of view of not wanting to be criticised and to avoid clear risks. But the rhetoric has changed. It is not so much about just avoiding the negative; it is about seeking the opportunities in the positive.”
Wood for the trees
This shift, however, has lead to some ambiguity. Choosing not to invest in an arms manufacturer or a tobacco company is a clear moral decision, says Kilpatrick, but, when it comes to the wider concept of responsible investment, waters are more muddied.
“Trustees are best placed to decide what is right for their charity based on its core values, but when we start to talk about positive impacts on topics outside of the charity’s remit such as climate change or social issues, I think there is some confusion about what that really means,” she says. “There is confusion around whether you should sacrifice financial return, how individual investment managers approach ESG and how success can be measured.”
One reason why this presents challenges for decision makers is simply because of the sheer number of companies and funds that fall into the ESG category. Research by Legal & General using Morningstar as an aggregator in the UK equity space found over 250 different funds that are labelled ESG – each doing things slightly differently.
To navigate this, trustees and finance directors need to rethink their approach to the debate. “The conversation has to be more around what are you trying to achieve when it comes to something such as climate change,” says Kilpatrick. “You might just want to wash your hands of the risk of being associated with the energy industry or oil and gas companies and divest, but that does not really feed into the narrative about how we are going to move to a lower-temperature environment. In fact, by divesting, you could very easily be increasing holdings in companies that are financing the activities of the fossil fuel industry, depending on how far down you dig.”
Sustainability is key
To help focus some of the thinking around ESG investing, Kilpatrick suggests trustees should be looking at sustainability as a key indicator. “The big idea underpinning ESG investing and why it has become so popular is that companies engaged with it are, ultimately, better run. If you address Environment, Social and Governance issues and future proof your company, then you end up generating returns for investors for longer, which in turn feeds into long-term financial sustainability.”
The role of a fund manager in all this, says Kilpatrick, is to avoid knee-jerk reactions and gather as much data as possible to steward assets effectively. “This can be tricky with ESG as a lot of data isn’t readily available as yet, but transparency is really key. We push for the utmost disclosure of data. A company cannot truly be assessed until you are aware of the starting point. Then you will be able to track progress.”
Trustees also need to ask whether their fund managers are helping to drive positive change in the organisations in which they are invested. “Trustees need to know how their manager is using their shareholder power for maximum impact. Are they engaging with companies, meeting with them and talking about ESG issues?”
Responsible investing is new and it will get easier as more data becomes available and metrics devised, says Kilpatrick. “But one thing is for sure: it is not just something nice to have in your investment strategy any more; it is becoming a serious concern.”
Nancy Kilpatrick, Head of unit trust relationships – Legal & General Investment Management
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