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Sustainability: Sustainable investing pathways for managing portfolio performance

November 4, 2022

Katie O’Sullivan, WTW’s Senior Director speaks to EY’s Will Compton about how organisations globally are developing how they manage their sustainability goals and requirements and how much progress is being made to manage the sustainability performance of investment portfolios amidst a changing reporting and governance backdrop.
ESG and Sustainability|Investments|Climate
Climate Risk and Resilience|ESG In Sight
Sustainability: Sustainable investing pathways for managing portfolio performance

Video transcript

Sustainability: Sustainable investing pathways for managing portfolio performance


SPEAKER 1: Welcome to WTW's ESG In Sight Spotlight Series.


KATIE O'SULLIVAN: Hello, my name is Katie O'Sullivan. And I'm joined by Will Compton, a pensions consultant at EY. Hi, Will. Thank you so much for talking to me as part of our ESG campaign. Sustainability is clearly a huge issue in our society. And businesses have a large part to play. What themes are you seeing in terms of these organizations setting their sustainability goals?

WILL COMPTON: Yeah, so when it comes to sustainability goals, I guess I'll distinguish between climate, those climate-related goals and non climate-related sustainability goals. So if I take the latter first, within that, I'd also make the distinction between businesses and organizations and asset owners. And by asset owners, I mean pension funds, insurers, family offices, endowments, those types of organizations.

So taking businesses first in their sustainability goals, they're very much setting goals that are pertinent to the sectors and geographies they operate in. So for example, a food and beverage company may be setting goals in relation to food wastage or labor practices in their supply chains. A clothing company, for example, may be focusing on using sustainable materials in their products and water wastage and those sort of themes.

So businesses are very much focusing on sustainability goals that are pertinent to their sector and their business. And that's where they can have a really big impact because they know those areas. So that's really important.

Asset owners on the other hand, they're financing hundreds and thousands of different businesses and projects. So they're taking a bit more of a thematic approach to setting sustainability goals. So often they might be focusing on particular sectors or portfolio companies, or there may be certain themes. Like board diversity is a really important one that a lot of asset owners are engaging on at the moment.

So that's non climate-related sustainability goals. When we look at climate, we're seeing more commonality between businesses and asset owners and the vast majority of sustainability goals being set that are aligned and consistent with the Paris Agreement. So achieving net zero by 2050.

Now, in the last couple of years, I think some of the climate science has become a bit more worrying since the Paris Agreement. We've also seen improvements in climate data. We've seen improvements in carbon accounting methodologies. I guess that impetus from the climate science but also the improvement in data and reporting have really encouraged more and more businesses and asset owners to set more ambitious targets.

So we're seeing a lot of organizations setting targets to hit net zero by, say, 2040 or even 2035. They're also setting interim targets around that journey. And that improved data, those improved methodologies are giving them more confidence to set those targets.

KATIE O'SULLIVAN: Regulation is playing a key role in terms of driving change related to climate. Do you think frameworks like TCFD are helping organizations in understanding the progress they're making?

WILL COMPTON: I mean, definitely. I mean, TCFD, for example, I think one of the really powerful aspects of TCFD is that it's got people talking. So it's not just about reporting on quantitative metrics in relation to climate, you need to set a strategy when it comes to climate. And you also need to set a governance structure and then report on that.

So TCFD has often been the impetus that people needed to start speaking about climate, very senior levels asset owners and within businesses and organizations. So they're thinking around, what is our strategy on climate? What are the risks and opportunities we see in climate? What should our ambitions be? How do we need to change our governance and processes to manage them or capture the opportunities?

So TCFD has really been a spark to get conversations going. And some businesses weren't speaking around climate, but TCFD has forced them to. One of the other beauties of TCFD in particular is that it creates a consistent framework that all businesses and asset owners are reporting under. So there is that commonality.

And there are also public disclosures. So there is that sort of public accountability that's been created. And that's sharpened a lot of people's minds when it's come to climate. You can't just think about this in-house. There is going to be that public accountability.

So TCFD, I think, has been extremely useful getting the conversation on climate started and progressed. In terms of actually reporting, some of the climate data is still in its infancy or progressing. So actually some of the quantitative aspects of TCFD reports doesn't always make comparability that easy. But we're on a journey there. And it is improving. But over the last couple of years, I think TCFD has just been really powerful in getting the discussion going.

KATIE O'SULLIVAN: With all those reporting and regulatory requirements, how much progress do you think is actually being made in terms of integrating sustainability into investment portfolios?

WILL COMPTON: Yeah, good question. So looking investment portfolios, I mean, it's pretty difficult for investors to actually navigate the market. They never had so much more choice around different investment funds and asset classes that may have a sustainability aspect to it. But actually understanding how influential sustainability is to investment decisions, so how is it actually influencing in investment decisions is actually really difficult to navigate.

So on one hand, you have, for example, things like impact funds that have explicit financial objective. But they've also got a sustainability objective. So for example, it may be providing finance to a project that's creating fresh water or building the infrastructure for fresh water in communities that perhaps haven't got access to that. And that will be a stated objective of that impact fund.

So impact funds have the clear link. We've also seen the emergence of a lot of indices that are related to sustainability areas, in particular climate. So your traditional index is weighted by the market capitalization of all the businesses that are in that index. We are seeing climate indexes where actually the financing, so how much is allocated to each business is based on, for example, maybe some carbon metric and how well they're performing.

So those that are performing better on climate metrics get more financing than others, or it may be related to how progressive they are with their net zero plans and that transition. So we are seeing quite a lot of innovation in the passive space as well.

But it is very difficult to actually navigate where there isn't that explicit link. A lot of asset managers will talk about sustainability. But understanding whether they're just paying lip service to it or it's genuinely influencing investment decisions can be quite difficult. So the due diligence is really important.

The other area where sustainability is a really important investment portfolios is around stewardship. And we're seeing more and more investors cooperating, collaborating to really have an impact with their engagement with underlying businesses.

And what's seen as best practice in this area has changed probably over the last couple of years. So it's really important now that if you are engaging with a business that you are setting time-bound, outcome-based objectives. And by that, I mean setting an objective saying, we want to achieve this within the business that we're financing within these time scales. And if we don't see that, these are the consequences of that.

And often they're in relation to reducing the level of financing you might be providing that business. So there's been a lot of progress in terms of engagement and stewardship. And this new outcome-based, time-bound objectives are really, again, pushing the conversation on.

KATIE O'SULLIVAN: Clearly, there's a lot of innovation in this area within the asset management space. And when you combine that with the focus on stewardship and engagement, like you mentioned, how are these investment firms organizing themselves to deliver on all of this?

WILL COMPTON: Yeah, so we're seeing two models investment firms are taking. Most investment firms are setting up or have already set up responsible investment teams. But the remit and responsibilities of those teams differs. So on one hand, we're seeing larger responsible investment teams being developed. And they're responsible both for developing strategy, developing the policies in relation to sustainability, but also then implementing them throughout the business and individual investment desks.

On the other hand, we're seeing a model where there's probably a leaner responsible investment team that's primarily responsible for policy and strategy. And then the actual implementation of those policies and that strategy is then being delegated to parts of the business or actually individual investment desks.

Now, there are merits and drawbacks with both approach. Having a team that is responsible for both strategy and implementation, that creates sort of clear accountabilities and ensures consistency across the business. However, if you look at the other model and actually separating strategy and implementation, it means that those policies are being implemented by people that are genuine experts in that area. So there are merits of both approaches.

So that's the macro level, the more micro level of how organizations are setting up and sort of governing themselves. We have seen the level of training around sustainability issues just go through the roof. So senior management board are getting more training on sustainability. It's moving up the agenda. But also all staff are getting training. It's no longer acceptable just to assume that sustainability is addressed by the responsible investment team. It's a responsibility and expectation of everyone throughout the business.

And as a consequence of that, we're seeing a lot of people having sustainability objectives and also paying promotion related to sustainability areas. And that's not just again in the responsible investment team but the wider business. So there's been changes at both a sort of macro level and micro level in actually embedding sustainability throughout organizations.

KATIE O'SULLIVAN: That was really interesting, Will. Thank you so much for your time.


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