A positive charge

12 min read 13 Apr 21

Ben Constable-Maxwell, Head of Impact Investing at M&G Investments, is one of the driving forces behind the move to integrate ESG, sustainability and impact investing into fund and portfolio management decisions.  In this Q&A, he talks to Sue Whitbread, Editor at IFA Magazine, about how and why ESG integration and impact investing are underpinning successful investment strategies for the future.

IFAM: Why should advisers be interested in ESG?

BCM: There are a number of compelling reasons! It is widely accepted that environmental, social and governance factors (ESG) could have a material impact on long-term investment outcomes. Understanding ESG issues – both risks and opportunities – is therefore fundamental to accurately interpreting long-term risk and return. 

Advisers also have a responsibility to understand how their clients’ investments are being managed in ESG terms and to use that to hold fund managers to account. For example, there is an important distinction to be made between ESG integration – the explicit and systematic inclusion of ESG factors in investment analysis and investment decisions, where these are meaningful to risk and potential return – and investment products that have an explicit sustainability or impact-related goal. Advisors can play a hugely important role in helping their clients to build this understanding.

There is then investment performance to consider.  We believe incorporating ESG factors improves the investment decision-making process and can potentially lead to better risk-adjusted financial outcomes for investors.

Finally, there is client interest. A growing number of investors are focused on social and environmental issues and are interested in how their investments relate to them. It is essential today that advisers are prepared to discuss this with their clients, and can introduce them to suitable products, whether the desired focus is on ESG primarily for risk management purposes or whether they want to put their investments to work in a sustainable or impactful way. We think this dialogue can further build the relationship between advisors and their clients.

IFAM: What do you see as the driving factors behind the shape of the ESG landscape this year? 

BCM: New regulations will continue to push companies and asset managers to disclose more information. In Europe, Sustainable Finance Disclosure Regulation (SFDR) came into effect in March 2021 and will lead to enhanced disclosure by asset managers that promote sustainable investment funds. The aim is to increase transparency and comparability for investors, which can only be a good thing.

There is also the UN Climate Change Conference (COP26) coming up in November 2021. I expect this event, which is being hosted in Glasgow, to intensify the focus on climate change as an urgent risk and on how investors and companies are managing their exposure to – and addressing – that risk.

Alongside the focus on climate change, rising awareness of the other systemic environmental challenge, biodiversity loss, will inevitably accelerate in 2021. As yet this has not received the attention that Climate has but that is changing.

Then there is the ongoing pandemic, of course. In 2020, COVID-19 increased awareness of wide-ranging societal risks in investors’ minds, from public health to social inclusion, and this will continue this year.

And the issue of diversity will continue to shape the ESG landscape as we go through this year. Importantly, I think investors’ focus will expand beyond gender to other aspects of diversity.

IFAM: M&G has been a long-standing exponent of ESG and impact investing. You have the specific focus funds but how does this approach permeate more broadly through M&G’s fund range and different asset classes in which you invest? 

BCM: We should start by trying to distinguish between these terms – of ESG and Impact Investing. They are linked but distinct. All our investment strategies are committed to integrating ESG to deliver improved long term outcomes for our funds and our clients. This process has been ongoing for some time, certainly accelerating in recent years. Sustainability and Impact investing are further up the curve, recognising not just the effect of ESG/sustainability issues on our investments but also that our investments could have an impact on real-world social and environmental challenges and outcomes. 

Some think of ESG as being an ‘outwards-in’ approach, that it’s about how external ESG factors affect our investments, very much linked to our fiduciary duties. Impact investing is the other way round almost - more of an inwards-out effect. It’s about focusing on how our investments affect the outcome of major societal challenges, as well as delivering an investment return.  

More and more of this latter perspective is influencing mainstream investing. Investors are thinking  about the broader impact of their investments as well as developing dedicated impact investing strategies. This is the direction of travel for M&G and hopefully for our industry too. 

As these developments accelerate, we need to be clear about definitions and distinctions. Our impact funds have an explicit and dual objective to deliver investment returns but also to generate social and environmental impacts. The big background risk is that investors greenwash or impact wash or overclaim about what they do. So whilst we are mindful about the value of moving towards a greater focus on impact across all our investments, we need to be clear to our clients about each fund’s mandate and objective and what outcomes they are designed to achieve, thereby minimising this risk of overpromising or overclaiming. 

IFAM: With increasing emphasis on disclosure and transparency, are there particular tools you find useful for assessing impact/sustainability of individual businesses? 

BCM: Starting at the foundations, at M&G we have a well-established ESG integration programme which employs a broad range of tools and data to inform and enhance our investment thinking. This is supported by our sustainability and stewardship team but is really put into practice by the analysts and fund managers.  

We use a range of information and data sources. For us information from investee companies is the primary source of our ESG analysis and a crucial part of our stewardship role. As part of our integration approach we aggregate selected data from external providers into an internal scorecard and toolkit. This can sit on fund managers’ desks and while it incorporates information and data from companies and third parties, it also includes the M&G analysts’ informed view on the issues at hand. So it’s not just the work of the Sustainability & Stewardship team, it’s the sector analyst giving their specialist view too. It’s a collaborative effort. 

On alternative data sources, we’re using them more and more. We have developed tools to understand the risks and opportunities arising from various climate change scenarios, giving us a richer, more forward-looking perspective on this crucial issue. On challenges like health, supply chains, biodiversity and others, there are varied data sources that can support our analysis. On biodiversity for example, investors need to consider how our investments are reliant on the natural world and can either support it or damage it. Useful tools here include using geo-spacial mapping data to help us understand the ecological footprint of an investment, highlighting where a company might be contributing to deforestation through its business activities. Impact investors can invest in companies providing solutions to address this huge challenge, for example by rebuilding natural eco-systems.

Which brings us to our impact investing approach, where we use all these approaches and more. When a fund has an objective to contribute to the Sustainable Development Goals (SDGs)*, we need to assess that contribution and measure the impacts as effectively as possible. We conduct our own analysis which incorporates company-reported information and independent data sets, but where there are gaps in the data we can also look, for example, at academic reports into how social inclusion can be boosted by access to finance, or scientific studies on improved health outcomes from a particular treatment. We are exploring tools which allow us to conduct an independent ‘net impact’ assessment of a portfolio, supporting our analysis to ensure that our investments, while contributing to one goal, are not negatively affecting another goal. 

IFAM: Having identified target investee companies, does liquidity cause many problems for you? 

BCM: This will vary for different asset classes. For impact investors in public markets, investing in listed equities for example obviously makes liquidity easier. Part of our aim in setting up a positive impact investment approach was to help democratise impact investing – to be able to make these investments available to the general investing public. The higher liquidity in public markets is important in enabling us to deliver on that goal. 

But within listed markets there are still ranges of liquidity. In our Positive Impact strategies in Equities we focus on three types of investment. It starts with ‘Pioneers’ or early-stage – sometimes less liquid - businesses which are using innovation to deliver positive long-term impacts on social, environmental and economic challenges.  Then we go up the scale towards ‘Leaders’ , the more mature, established business models that tend to be more liquid. In the middle are ‘Enablers’ which are using technology or other skills to help others generate a positive impact.

We think in a listed-equity strategy it makes sense to have a focus on those earlier-stage pioneering businesses, but in the interests of overall portfolio liquidity you need a decent balance between smaller, medium and large-sized businesses. So, in listed-equity, liquidity helps you define the type of investment and provides context to the type of impact you can have, but it’s not a massive challenge. 

In the traditional home of impact investing – private market or VC investing – liquidity is clearly more of an issue. Such strategies represent the origins of impact investing but are not necessarily available to the public through investment funds. We have impact-focused strategies in private & illiquid debt and private equity, and in development in Alternatives, which invest for impact where liquidity is more of a constraint. However, investment opportunities are growing fast in these areas as the world recognises the need to scale up the capital needed to solve the most urgent societal challenges. 

IFAM: Is the popularity of responsible investing leading to market anomalies? 

BCM: In public markets, the shift towards sustainable investing - and an increasingly supportive regulatory backdrop - has been leading investors towards a focus on certain types of company, most obviously in areas such as clean tech or renewable energy.  

As a valuation-focused investor we’ve got to be mindful of that. Long term fundamentals in this area are compelling but we avoid over-heated areas where momentum has extended beyond those fundamentals. If we look at Tesla for example, it’s a fascinating, transformational business but we’re very mindful of valuation as well as a number of ESG-related concerns. We need to be able to see a return on our investment over the long term. 

For our listed equity impact approach, our rigorous “triple i” impact investment approach means that we are strict about the types of investment we make. We are looking for companies not only with high quality business models but with a clear societal purpose and measurable, positive impacts, where we want to understand the proportion of the revenues which contributes to the positive impact. Our stringent approach here naturally steers us away from some of the hotter areas that don’t live up to our scrutiny.

However, we should add that the more sustainability is incentivised by technology, societal preferences and regulators, the more the investible market grows, and more and more companies enter our universe as potential ‘positive impact’ candidates. 

IFAM: How powerful is the growing force of investor interest and consumer demand being felt by the businesses themselves and, if so, is it driving any different habits amongst those businesses? 

BCM: We’ve seen transformational change here in recent years. Investors are piling pressure on companies to articulate their sustainability strategy, to disclose better ESG data and increasingly to articulate their purpose and how it will enable them to deliver on their societal responsibilities. This has led to a sea–change in corporate disclosure and strategy around sustainability. It is now top of the agenda at board meetings and is increasingly being put directly into incentives for management such as executive remuneration targets. This pressure has moved beyond the need for policies towards a focus on actual performance and evidence.

Beyond investors, huge pressure is now being exerted by consumers, regulators and civil society. Is this pressure being felt by businesses? Yes, it absolutely is. Companies are having to face the fact that if their business model is unsustainable they are going to have to change or become defunct. 

Not all businesses are embracing this change, but more and more are, which is a much-needed development.  One of our roles as investors is to check whether companies are ‘walking the talk’ with regards to their sustainability agenda. As well as setting out a polished, high-level strategy or signalling a change in objective, what are they actually doing on the ground to demonstrate the genuineness in their purpose, via tangible actions, performance and capital allocation? The best examples have their purpose flowing clearly right throughout the organisation and its culture.

IFAM: What do you believe will be the key factors and drivers of growth for ESG in the years.

BCM: I think a continuation of these broad drivers, including regulation and societal preferences, will drive the long-term growth of ESG investing - and increasingly impact investing too.

ESG integration is now (rightly) expected as standard for all investments. Investors are no longer just seeing ESG as a risk that needs managing, but as a positive opportunity too. There is growing recognition that we can invest for positive impact – to address the challenges facing the planet and its people, while patiently pursuing financial returns. 

There is also mounting recognition amid the accelerating climate and other crises that we need to rethink how the economy is set up. To address climate change and environmental degradation, we need to move towards a more circular economy, where inefficient production and consumption models give way to those where materials are reused, repurposed or recycled and where waste can be used as a valuable resource in a closed loop system. Businesses and industries that embrace this will be well positioned. I expect this to align with a need for solutions to address the growing focus on nature and biodiversity, on which the global economy is fundamentally dependent.

As we are now in the Decade of Action to achieve the UN’s Sustainable Development Goals (SDGs) by 2030, there is an urgent imperative to address society’s greatest challenges, with sustainable and impact investors having a crucial role to play. Guided by the SDGs, these investors can help galvanise efforts to raise impact capital and to mobilise it in a targeted, measurable way towards these solutions.

* While we support the UN SDGs, we are not associated with the UN and our funds are not endorsed by them.

By Ben Constable-Maxwell

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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