Susanna Rust charts the evolution of responsible investment over the past 20 years
There are many ways the story of the evolution of responsible investment over the years could be told. The gist of it is captured well by Flavia Micilotta, executive director at the European Sustainable Investment Forum: “The European SRI market has evolved from being principally focused on ethical exclusions of specific companies and sectors to one that also seeks the integration of ESG factors across all asset classes in mainstream fund management.”
This points to how the development of responsible investment can be dated – although not necessarily helped – by its abbreviations. What was once called ethical investment evolved into socially responsible investment (SRI) towards the end of the 1990s before morphing into environmental, social and governance (ESG) later. Each change suggested not just a shift in terminology but a development in the strategies employed.
Isabelle Cabie, global head of responsible development at Candriam, notes that the best-in-class approach, which involves investing in companies that score higher than others on selected ESG criteria in a given universe, was adopted in France and Belgium from 2000.
Meanwhile, institutional investors in the Nordic countries and the Netherlands were embracing a normative approach associated with engagement. Recently there has been a convergence, Cabie adds.
Generally, however, the next major development after ethical investment was the integration phase.
“It was recognised that you needed to bring mainstream investors into the ESG agenda and that responsible investment considering ESG factors was much more than taking an ethical stand on issues,” says Fiona Reynolds, managing director at the Principles for Responsible Investment (PRI). “It was about thinking about risk in a more holistic way, and about how you think about ESG risk across your investment portfolio.”
Matt Christiansen, global head of responsible investment at AXA Investment Managers, says this phase is about ESG factors being seen as “input” into investment management that could enhance the “opportunity set of information” and improve risk-return profiles. The establishment of the PRI is seen as the “birth of that world”, he says.
Underpinning the integration phase has been the argument and growing recognition that ESG issues can affect financial performance and that investors should therefore take these into account.
This is the point in the evolutionary story, where it is no longer possible to ignore fiduciary duty and how it relates to ESG themes.
As argued by the PRI and others in a 2016 report, “[t]he manner in which fiduciary duty is defined has profound implications” and “relatively modest changes in interpretation and practice of fiduciary duty [can] catalyse rapid change in the importance assigned by investors to environmental, social and governance issues”.
“The European SRI market has evolved from being principally focused on ethical exclusions of specific companies and sectors to one that also seeks the integration of ESG factors across all asset classes”
Although, it falls outside the 20-year horizon of this analysis, arguably one of the most defining moments in the evolution of ESG investing, certainly from the UK perspective, was the 1984 Cowan v Scargill case.
The court case was brought in the midst of an industrial confrontation between the government and coal miners. Arthur Scargill, then president of the National Union of Mineworkers, wanted the trustees of the its pension fund to avoid investment overseas or in alternative sources of energy to coal. The judge, Robert Megarry, dismissed the case, ruling that trustees had to act in the best interests of beneficiaries and defining ‘best interest’ as being the greatest financial return on investments subject to a degree of prudence.
In a landmark report for the UN Environment Programme Finance Initiative in 2005, law firm Freshfields Bruckhaus Deringer said the Cowan v Scargill case had been “widely regarded as a leading authority on investment management”, and “led many investment decision-makers to believe that they are required to maximise financial returns on an investment-by-investment basis and that the courts will overturn decisions made without that profit-maximisation objective in mind”.
The case had coloured the position in the UK on the integration of ESG issues in the context of fiduciary duty, but had been “misunderstood”, according to the law firm. The conclusion of its report was that integrating ESG considerations into investment analysis is permissible but in certain circumstances mandatory.
However, this view was hardly universal. Why else would the PRI, with various UN bodies, have 10 years later felt obliged to produce a report entitled Fiduciary Duty in the 21st Century, reprising the argument that fiduciary duty “creates positive duties” on investors to integrate ESG issues to mitigate risk and identify investment opportunities? In 2016, the London-based think tank E3G, along with campaign organisations such as ShareAction, called on the European Commission to “send a clear message that fiduciary duties are not a barrier to integrating ESG information into their investment decisions”.
“This would end a debate that unnecessarily continues in some parts,” it said.
From a thematic perspective, recent developments in ESG investing are connected with environmental questions and climate change in particular.
Although having been on some investors’ minds for a while – the Institutional Investors Group on Climate Change was founded in 2001 – climate change has shot up the agenda as a relevant investment consideration.
There was a series of pivotal events, including the development of the stranded-asset theory on fossil fuels and its entry into mainstream investment management discourse, courtesy of reports produced by the think tank Carbon Tracker, first in 2011 and again in 2013.
Then there was a series of events in 2015: analysis on the impact of climate change on asset class returns by Mercer in its Investing in a Time of Climate Change report from June; shortly thereafter the “tragedy of the horizon” speech by Mark Carney, the governor of the Bank of England, and the proposal by the Financial Stability Board, which he chairs, for the Task Force on Climate-related Financial Disclosures; and then international agreement on climate change reached at the UN conference in Paris in December.
Sharing her thoughts about milestones in ESG investing, Faith Ward, chief responsible investment and risk officer at the UK’s Environment Agency Pension Fund identified Carney’s speech and the work done by the taskforce as “game-changers”, having “monumental impact”.
France’s energy transition law, with the Article 173 requirement it imposes on investors to report how their policies align with domestic and international climate-change targets, is also hailed as ground-breaking.
Andrea Rossi, chief executive officer of Axa IM, recently said that “responsible investing will continue to move from ‘niche’ to the ‘norm’, driven by regulation and client demand”.
It is a compelling view of the transition made in the ESG field, from its origins in ethical investment, but also to its future. There is plenty of scope for responsible investment to further evolve, including via the extension of ESG integration; its traditional home is public equity, but more work has started to be done in bonds and alternative asset classes.
Impact targeting next
As work on ESG considerations continues, another development is unfolding. According to Axa IM, the “age of impact” started roughly in 2014. Christiansen describes it as “the final phase” and about being about “the colour” of investments.
In many ways, impact investing is not new. And yet the UN Sustainable Development Goals, agreed on in September 2015, have, arguably, lent fresh momentum to the notion of investing for impact. Large pension investors in the Netherlands and the Nordics are experimenting with the goals as a means of framing and communicating their investments, and placing them in the wider context of their contribution to some of the world’s main environmental and societal challenges.
[The article was amended after publication to state that the best-in-class approach was adopted, rather than developed, in France and Belgium from 2000.]