Sustainable Standpoint: ESG was never more misunderstood than in the past year

In the first part of this new series, ESG industry experts reflect on 2022 and share predictions for 2023

Sustainable Standpoint is a new ESG Clarity series focusing on reflections of developments in ESG investing over the past year, and predictions for potential milestones in 2023.

In part one, Tim Cockerill, Peter Michaelis, Cathrine De Coninck-Lopez, Leon Kamhi and Nick Scullion share their thoughts on biodiversity, healthier lifestyles, ESG tools, “great confusion” surrounding ESG and cleaner electricity.

Biodiversity is under massive threat globally

Tim Cockerill, investment director, head of responsible and values based investing at Rowan Dartington

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

Keeping the Faith! After five years of good performance and a growing belief in ESG and sustainable strategies, 2022 dented that belief for many – was it just a passing trend after all? ESG funds have been seen as different, and the industry has made a thing of it too, but the reality is that companies in ESG funds are no different from any other company, it’s simply the funds process that identifies those which are suitable. Most fall into the growth camp and were never going to perform well in a value market. But market conditions this year and the drivers have shortened investors’ time horizons. We’ve had to re-emphasise the long-term nature of the underlying drivers behind many ESG mandates – the climate crisis hasn’t gone away, urgent action is needed, huge investment is needed and companies are a major route to many of the solutions needed.

Please provide one prediction for the ESG investment world for 2023.

The more you drill down into any ESG subject the more complex it becomes – everything it seems is interconnected and seemingly unrelated issues can be found to be linked – and then there are the unintended consequences. Producing food more cheaply has always been seen as desirable, and the cost-of-living crisis understandably hardens that thought. So agricultural businesses have cleared hedges, drained ponds and wetlands, implemented continual planting, put up better buildings and storage facilities and, of course, used fertilisers and pesticides and production per acre has soared. No-one set out to persecute the tree sparrow but since 1970 populations have declined 95% because of the aforementioned. Biodiversity is under massive threat globally and it’s a problem because half the world’s economic output is dependent on nature, and it acts as a massive carbon sink. The acknowledgement that our world is interconnected and interdependent needs to gain significant traction – whether it’s the climate crisis, biodiversity loss or social upheaval and unequal societies, they are all inextricably linked. The introduction of the Taskforce on Nature-related Financial Disclosure (TNFD) is to help companies assess their impact and I’m predicting 2023 will see a much greater focus on this.

Improving quality of life and living standards

Peter Michaelis, head of the Liontrust Sustainable Investment Team

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

It’s no secret that 2022 has been a challenging year for investors, with volatility across almost every asset class and major macro-economic and political uncertainties ongoing. This has particularly been the case for those investing sustainably. And yet, looking to 2023, we are more excited about the prospects for our funds than we have been in years.

We have great confidence in the future. Sustainable companies have stronger growth prospects and better management than the market appreciates.

A legitimate challenge to our approach would be to ask whether our sustainable investment themes have run their course. This would only be the case if we had solved every problem and satisfied every need; we are a long way from that! There is still plenty of growing to do for sustainable companies.

Please provide one prediction for the ESG investment world for 2023.

The desire to improve quality of life and living standards continues to be an important driving force in the global economy and will provide a strong tailwind to the companies exposed to these trends. Our job is to back the rare businesses that can harness these tailwinds and generate strong profitability over the long term with durable competitive advantages.

Our ‘delivering healthier foods’ theme seeks to find those companies that are helping to improve the nutritional characteristics of our food and tackle the obesity epidemic. It is predicted that by 2026, the market for healthier food and drink will be worth around $1trn and an area of the market that we particularly like is in the flavour technology space. It is a cost that rarely makes up more than 10% of food and beverage products but is extremely important to the end consumer. In our view, this is not just a trend, but a market experiencing structural long-term growth.

Much of our sustainable thinking at Liontrust focuses on a cleaner and safer world in the future but a third goal requires people to be healthy enough to enjoy this. With a fifth of the world’s population expected to be overweight or obese by 2025, and related diseases impacting both life satisfaction and expectancy, there are issues we simply have to face.

We are closely watching the Transition Plan Taskforce

Cathrine De Coninck-Lopez, global head of ESG at Invesco.

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

2022 has highlighted the broader complexities of ESG investing and brought the role of ESG investing into global discourse. The ESG landscape has evolved rapidly, globally and in a very public way. Coupled with lack of clear definitions, varied interpretation of new rules and a spectrum of personal values, it is no wonder that there is widespread confusion around the ESG world.

To address this, we standardised ESG language to enhance clarity while innovating in solutions and data. First, we adopted a firmwide ESG nomenclature, recognising a spectrum of ESG investing objectives and approaches that can be customised to client needs. This is a proprietary internal standard that can be mapped to regulations across regions. We also deepened innovations in ESG strategies through launching a range of thematics including net zero, social progress and smart foods. Finally, these strategies are supported by strengthening our data capabilities including the launch of the ESGCentral tool for portfolio ESG analysis that can facilitate ESG reviews and reporting.

Please provide one prediction for the ESG investment world for 2023.

While much of ESG investing has been focused on climate mitigation previously, 2023 will see a broadening of focus into adaptation and transition plans.

Climate adaptation refers to the ability of people and nature to adapt to climate risks. The most immediate issue is that of physical risks. Focusing on habitat protection, flood and drought management, water and energy conservation, and retrofitting properties for changing weather conditions, amongst other actions, are needed in a changing world. In 2022, adaptation finance only represented around 10% of issued green bond universe but this could grow significantly with particular emphasis on use of proceeds for emerging markets.

For companies, we are closely watching the Transition Plan Taskforce, which was launched during COP27 in November 2022. The taskforce is in consultation until February 2023, but we have already seen companies issuing their versions of transition plans and expect more reports coming out in 2023.

ESG was never more misunderstood than in the year that passed

Leon Kamhi, head of responsibility at Federated Hermes

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

It is odd that having entered the investment industry’s lexicon all the way back in 2006 with the launch of the Principles of Responsible Investment (PRI), it feels like ESG was never more misunderstood than in the year that passed. Therefore, difficult as it might be there was no surprise that regulators sought to bring order and seek to get some definitions on what might constitute an ESG or sustainability fund and stem the tide of greenwashing.

For our part, we sought to communicate a clear distinction between thematic ESG funds – be they exclusionary or impact – which represent an investor’s set of values or ethics and ESG funds, and which integrate material ESG performance drivers alongside traditional performance indicators with the objective of long-term wealth creation for investors. In addition, we heavily promoted to clients, standard setters, regulators and investment peers the value of stewardship to deliver sustainable outcomes and improve the performance of investees. Stewardship is key as an integrated part of both types of ESG funds.

Please provide one prediction for the ESG investment world for 2023.

My prediction for 2023 is a continuation of 2022. That we can expect continued polarisation of views on ESG and an even greater legal scrutiny of investment managers’ activity, which, in turn, may lead to the stalling of necessary policy changes in some parts of the world, and companies being unreceptive to investor engagement and putting off the capital allocation actions needed to develop a green economy.  Furthermore, increased regulatory and disclosure requirements are likely to be on their way distracting resources from spending time on stewardship and responsible investment with the need to deliver a plethora of new reports. I hope I’m wrong!

Continuing clean electricity transition

Nick Scullion, manager of the FP Foresight Sustainable Future Themes Fund.

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

The Russian invasion of Ukraine and subsequent energy supply shock has been used by some as a tool with which to doubt the wisdom of the global clean energy transition. However, attributing the energy price spike to the UK’s efforts to increase renewable energy generation capacity is a myopic argument, which fails to consider that increasing the capacity of wind and solar energy generation is one of the few levers that has been pulled to reduce the UK’s dependence on imported natural gas.

Though the energy crisis may have delivered a stay of execution for coal in the short term, it has become abundantly clear that clean energy in the form of renewables and nuclear now holds the key to energy security. The invasion represents the end of the European addiction to Russian hydrocarbons. In the face of criticism of renewable energy and strong share price performance of fossil fuel energy producers, it has been important to see these events for what they are: short-term phenomena. The EU’s range of sustainable investment frameworks, the UK’s soaring proportion of renewable power, and the US’s game-changing Inflation Reduction Act highlight one thing: we are heading into a great acceleration of clean energy.

Please provide one prediction for the ESG investment world for 2023.

The energy price spike of 2022 has highlighted the UK’s stifling exposure to volatile global gas markets. Currently gas, as the last source of supply to meet demand, ends up setting the wholesale electricity price. The UK currently generates 40% of its electricity from renewables, which are cheaper than natural gas, yet the current market structure means these falling costs are not reflected in energy bills.

With UK power prices set by natural gas 84% of the time despite it representing less than 50% of the country’s power generation, 2023 will see lawmakers focus on a core goal: power market reform. In July, the government launched REMA – a major review into Britain’s electricity market design which is looking to ensure the cost benefits of cheaper energy trickle down to consumers in the long term. Innovative reforms are already being discussed including the splitting of the current single wholesale electricity market into two: one appropriate for economics of renewable generation and one for traditional fossil fuel-based sources. This would serve to decouple electricity and gas prices, help the cost-efficiencies of renewables be passed on to consumers and attract capital to finance the continuing clean electricity transition over the long term.

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Natalie Kenway

Natalie is global head of ESG insight for ESG Clarity and has been an investment journalist for 16 years. She won Editor of the Year at the Aviva Investors Sustainability Media Awards 2021, and was Winner...