ESG in Practice: The Future of Sustainable Funds

Mr. Borremans, how did sustainable securities perform during the stock market correction at the beginning of the year?

mixed. For us, ESG funds represent a fairly wide range of asset classes (stocks, bonds, money market instruments) and investment strategies. Since the beginning of the year, stocks have not performed particularly well compared to traditional indices. However, sustainable investing has a long-term focus and has performed very positively over the past five years.

What lessons can you learn from this volatility?

The volatility of recent months has not raised questions about the fundamentals of sustainable investing. The decarbonization of the economy, the energy transition, or the increasing demand for drinking water depend not on monetary policy of central banks, but on long-term trends. Short term fluctuations do not in any way harm its attractiveness. In fact, I would say that ESG funds that focus on better evaluating and understanding corporate governance and leveraging sound corporate governance should take advantage of challenging market periods.

How is that?

When the cash is flowing, there is no pressure to make the difficult decision about using the cash flow for capital projects or for stock buybacks. Therefore, the difference between long-term and short-term companies is not always clear. However, given the tighter credit terms, there appears to be a real difference in performance in favor of companies that preferred long-term investment over short-term austerity.

I created a fund that invests in family businesses. Does their governance tend to differ from that of others?

Leading ESG rating agencies apply strict analysis criteria that tend to favor the corporate governance model for diluted capital firms. This preference discriminates against family businesses, which we define as those in which the founders own at least one-third of the equity or voting rights. This becomes clear when it comes to board independence – it would be appropriate here to ask about the minimum 50% of independent board members. We estimate that 10% of the market has strong family ties and have published a study showing inadequate agency analysis. We believe that governance analyzes should be tailored to the ownership structure and current state of the company, rather than sticking to rigid models.

According to our analysis, the stock market performance of family businesses is very favorable in the long run, as their vision is longer than that of many other companies. So we launched an investment strategy in 2020 that takes advantage of this fact.

What interests do the top performers have – the interests of shareholders, employees, or customers? Does this topic not become relevant again now, when we are recovering from the pandemic and witnessing the so-called “Great Resignation”, the great wave of layoffs?

I agree with you. In this post-Covid era, millions of workers in the United States are resigning for a variety of reasons including quality of life, and there is a serious risk that skilled labor will become increasingly scarce and expensive. In corporate income statements, employees are a source of costs and liabilities in the form of wages, salaries, and pension contributions. Ironically, company culture and employee motivation for a joint venture are not reported as assets on the balance sheet. Accounting does not help us on this point.

Tomorrow’s companies must consider employees, customers, the environment and civil society.

We therefore included additional criteria in the ESG analysis of the companies. For example, we know that employee turnover varies with business cycle and industry, and we try to stay away from companies where turnover is unusually high. Companies with employee turnover above 15% renew their human capital every six years. This leads to hidden costs, but it is very expensive.

The “shareholder model”, which focuses on the interests of shareholders, is inadequate. Tomorrow’s companies must consider employees, customers, the environment and civil society. The ESG analysis aims to take these additional aspects into account.

What are the most important milestones for you in managing ESG?

Our roots in ESG management go back more than 20 years with the launch of funds that invest in sustainable European water and stocks. The range has grown over time, and other asset classes are also being offered in the field. Offer diversification has accelerated in recent years with the European SFDR rating. A year ago we transferred 50% of our money to the requirements of Article 8 and Article 9. We are now at 75%.

What are your priorities for the coming months?

We are committed to Net Zero Asset Management initiatives and science-based goals to make our facilities and operations carbon neutral by 2050. We are already structurally oriented towards a green economy, and against this background, we would like to publish a business plan with medium targets after 5 and 10 years by the end of the year.

If we want to constantly act in the interest of the environment and include only companies that do not harm the climate, only 5% of companies are in doubt. Is this not the dream of every fundamentalist?

The green economy is still largely in its infancy. Only 5-10% of exporters have adapted to this. It’s not much, but that’s how things look now. However, the green economy is growing much faster than the global economy, which is good news for investors and the environment.

Then what are we going to do with the remaining 90%? Refuse to invest?

Investor demand is very broad and heterogeneous, both in Switzerland and elsewhere. To meet this demand, we have developed investment strategies that favor securities that, although not top-rated, have significant potential to improve ESG. We are actively working with them to encourage fundamental change. A good example of this is the German company RWE. Five years ago, the power facility was a nightmare for every ESG investor because it was Europe’s largest carbon emitter.

If we wait until the company is 100% sustainable, we may miss the opportunity to participate in the dynamic of positive change.

The company has turned 180 degrees, committing to phase out all coal-fired power plants over the next 10 to 15 years and accelerate wind energy development with investments of more than €50 billion in green energy over the next decade. The difficulty is finding the right time to invest responsibly in these types of companies. Should I wait until the company is 100% sustainable? Or when the council announces a strategic change? If we wait until it is 100% sustainable, we may have missed out on the opportunity to participate in the dynamic of positive change.

What are the pitfalls of green classification?

First of all, there are obstacles in the implementation of the CSRD (Corporate Sustainability Reporting Directive) and starting from 2023 in the publication of the share of sales generated by sustainable activities. As investors, we currently have to rely on our own valuations. We were the first to have their clean energy strategy checked for compliance with the green rating.

This work is very time consuming, but it is indispensable because we are bound by transparency. This adjustment phase will take another 12 to 24 months. And we must not forget that the CSRD applies only to European companies, which make up less than half of global equity funds. Thus, the other half of the stock market will not be obliged to reveal the numbers unless foreign investors request that they move the numbers of their funds distributed in Europe.

Source: Taken from Le Temps, published on: 02-28-2022

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