The term ‘sustainability’ has found its way into our everyday lives, be it through the food we eat, the clothes we wear, or the means of transport we use. The term has also found its way into the finance world, where it has become one of the main drivers to change an investors behaviour. Ever since the theme’s early beginnings, terminology has been a subject of seemingly endless debate, stirring confusion and raising complexity unnecessarily. Unfortunately, things seem to have become more difficult rather than simpler as regulation picked up. However, if we think about the terminology in more depth and focus on the inherent meaning, it turns out to be quite simple and straightforward.

What are we talking about?

  • ESG describes data that goes beyond the usual economic and financial perspectives. There is an ever-growing amount of data that sheds light on environmental, social and governance (ESG) aspects of businesses and companies. ESG data provides an additional perspective or a toolset that broadens and sharpens our understanding of what we are invested in.
  • Responsible describes a way of doing things. Specifically, it entails a thorough, comprehensive, and holistic approach. In terms of investing, all aspects and perspectives are taken into account. Importantly, those include the ESG toolset as well. Thus, a ‘responsible’ investment process helps to better understand the risks and opportunities within an investment universe.
  • Sustainable describes an outcome; it is the consequence of a responsible action. From an investment perspective, those businesses and companies that score well in terms of ESG criteria can be called sustainable.
  • Impact describes a set of goals, something we measure. ‘Impact’ is a key pillar of a framework used to align, track, and readjust a strategy, putting data into action. There are certain investments that come with a predefined impact, corresponding measurement, and reporting tools.
  • Purpose describes a vision, a long-term goal reflecting individual beliefs and personal values. The definition and communication of a purpose has become an ever more popular tool for individuals and organisations to put a meaning to what they do and to align and streamline their actions. The finance business feels this structural change first-hand, as investors increasingly seek a purpose alongside performance.

Why is responsible investing relevant?

When talking about the growing relevance of responsible investments, three key drivers can be identified:

  1. Performance: Evidence suggests that ESG-focused companies fare better economically, which is mirrored in financial markets by better risk-adjusted returns.
  2. Purpose: Sustainability is a structural force, a shift in our society’s mindset. With the help of technology and social media, consciousness about environmental preservation, climate action, and social responsibility has grown. This change in people’s mindset and values is also spilling over to the investment world, changing the way investors make investment decisions.
  3. Regulation: Even before the pandemic, companies were already facing significant pressure from regulators to become more sustainable and more responsible for their actions. The corporate and finance world have key roles to play to support common political visions such as the Paris agreement or the United Nation’s Sustainable Development Goals (UN’s SDGs), and the pressure to do so is set to increase. The European Union’s sustainable finance and taxonomy efforts serve as a good example.

Does responsible investing pay off?

The short answer is yes, it does. There are exceptions of course and dependencies to the rule. The integration of the ESG perspective improves an investor’s ability to identify and understand the opportunities and risks. The economic logic is straightforward. First, sustainability in part determines the long-term growth potential of a market and business. Second, responsible practices define an organisation’s quality overall. ESG leaders are long-term thinkers, not short-term tinkers. Beyond the shareholders’ interests, they also care about all the stakeholders. They are agile, transparent, and accountable. Companies that embed these characteristics in their culture and their practices tend to perform financially better in the long term, because they are early in adjusting their strategy to structural change and because they control their everyday operations more closely.

The corona crisis has proven this logic to a large extent. When push comes to shove, the leaders can outgrow the laggards, as they are less distracted by fixing balance sheets and redefining strategies. In addition, responsible practices tend to resonate in lower risks of being caught up in a scandal leading to reputational backlash, litigations, and financial risks.

The investment logic is straightforward too. Financial markets value the likely economic success of ESG leaders, and their likely reduced risk profile. The corona crisis has largely confirmed these assumptions. Such strategies outperformed their benchmarks.

Some even posted strong positive performance in the face of crumbling financial markets, not least due to a traditional sector bias towards technology and healthcare, and away from oil-related investments. But they also managed to outperform on a sector-neutral basis, likely confirming that ESG leaders are better prepared for any crisis. However, it is important to mention that responsible investing is no recipe for everyday outperformance. The past months have shown that once a rally has matured, the high risks and low quality assets are quick to catch up as well. In such times, quality tends to underperform, and ESG is a tool to support a quality investment style.

What are the challenges with ESG data?

The evolution of ESG data is pivotal to the evolution of responsible investing. It all began with exclusions of values-adverse sectors such as tobacco, because of the simplicity of such an approach, and because reliable ESG data was not available. While it is easy to assess in which sector a company is doing business, it is much more difficult to assess the way it conducts its business. In the meantime, the comprehensiveness of ESG data has improved significantly. Companies report ever more comprehensive metrics and will soon be forced to do so by regulation in a standardized way. Investor demand created a niche for ESG data providers, whose methodologies continuously improve over time. Artificial intelligence and in particular natural language processing bring new ways of data gathering and aggregation. In terms of ESG data, we see three categories distinguished by the point of view and the relevance of human or artificial intelligence: reported, reviewed, and processed ESG data. A sound, reliable, and comprehensive process builds on sourcing data from different categories. Despite the evolution, several challenges remain in this area:

  • Coverage: The challenge to have data for all companies that appear in an investment portfolio as stocks or bonds, directly or indirectly via collective instruments such as funds.
  • Quality: The challenge to have reliable data. Reported data tends to be biased for various reasons such as the size of the company, its geographical base, and greenwashing. 
  • Data structure: The challenge to have a structure to aggregate data and put it to use.
  • Sovereigns: The challenge to have data on organisations that are not companies.

Does a portfolio have a CO2 footprint?

Generally, no. But for some exceptions, yes. Although this is an intensively debated topic, the answer should not be controversial. Economic activity causes CO2 emissions, respectively how we conduct the activity today. Any economy has three actors: the households (who mostly buy services or goods), the companies (who mostly produce services or goods), and the public sector (which does both). Economic activity is the circulation of goods or services within the economy, and the reciprocal circulation of cash flows including expenditures, sales, salaries, or taxes, in the counter direction. Ultimately and to put it simply, the CO2 footprint of any economy reflects the footprint of the average household’s consumption habits, because in the long run, companies and the public will only supply goods and services that are consumed by households. Thanks to various tools available online it has become simple to measure a households, or our personal footprint, and this per capita perspective should serve as the point of reference for any comparison.

How to invest responsibly with Julius Baer

Our investment process integrates the ESG perspective and has done so for many years. It has been and continues to be a journey of learning, refining, and extending. We believe that creating value sustainably requires a focus on cash flows and profits, and on responsible interactions with society as a whole. ESG is a tool-set to better manage risks and generate long-term returns. We also believe that every individual has their own personal point of view, reflecting values and beliefs, and thus holistic wealth management should not make any moral judgments on behalf of investors. Moreover, financial markets always put a value on assets and to be mindful of valuations is key for performance. At a certain point, ESG risks can be adequately priced, in the same way ESG opportunities can be overpriced from a conscious investment perspective. Our approach to ESG integration focuses on risk and opportunity identification, raising awareness, increasing transparency, and avoiding exclusions. The responsible investing process is part of a holistic responsible wealth management framework, complemented by philanthropic services: 

  1. We screen our universe with ESG data sourced from independent providers. Each objective, spotting ESG laggards/leaders, or instrument that serves a specific purpose, has its own methodology (a set of criteria).
  2. The Responsible Investment Committee validates the data signals. While all ESG risk cases are subject to validation, only specific ESG opportunity cases need to be validated. The committee engages with the experts to understand how the ESG perspective is embedded in their assessment.
  3. The Alignment of instruments to individual preferences and means. An investor’s objective tends to reflect different levels of sustainability. While ‘sustainable’ instruments can be core building blocks of a diversified portfolio, ‘impact’ instruments are rather satellites. Philanthropy brings the highest degree of a “do good” element, but it is a service, and not a financial investment.
  4. The final selection is straightforward; only instruments with a positive recommendations make it to a portfolio. The reward to investors is both in the sense of doing well, i.e. the high likelihood of long-term performance, and of feeling good, i.e. emotional benefits due to the alignment of the portfolio with personal values and beliefs.
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