Sustainable investment into a new highlight of asset allocation

â–¡ reporter Li Zhongxian

In a global investment environment full of uncertainty and complexity, one area is becoming a hotbed of opportunities – sustainable investment. In layman's terms, sustainable investment considers long-term environmental, social, and governance social factors, including responsible investment (RI), socially responsible investment (SRI), and environmental, social, and governance (ESG). “For asset configurers, joining sustainable investment standards can generate a certain business return, fulfill fiduciary obligations, and combine portfolios with broader social goals. It can generate higher return on investment and take on smaller Risk.” Scott E Kalb, senior consultant of the New Bretton Woods System and founder and CEO of KLTI Advisors, said in an exclusive interview with the China Insurance Journal.

Reporter: Can you brief us on the progress made in sustainable investment in recent years?

Scott: In recent years, sustainable investment has made many advances in reporting and analytical tools, enabling investors to better conduct long-term sustainable risk assessments of their portfolio companies. For example, the Global Reporting Initiative (GRI) guidelines for sustainability reporting were adopted by 7,500 companies. In addition, many organizations are committed to a variety of sustainable investments that provide useful resources, information and data. For example, the Carbon Disclosure Project (CDP) has measured greenhouse gas emissions, water management and climate change strategies for more than 5,600 companies in 80 countries and 300 cities.

In response to growing global demand and investor interest, the number of sustainable investment funds has increased rapidly and is focused on virtually all areas, from climate change to human rights to environmental, social and governance (ESG). Globally, $24 trillion is invested in sustainable investment strategies, most of which are funded externally. As sustainable investments enter the mainstream, multi-trillion dollar asset management companies are beginning to incorporate environmental, social, and governance (ESG) standards into their portfolio selection processes.

Reporter: As you know, which investment institutions in the world have done a good job in sustainable investment?

Scott: Speaking of sustainable investment, many sovereign wealth funds/government agency pensions are leading this investment trend and are having a major impact on global capital markets. Below, I will give two examples.

As a New Zealand sovereign wealth fund, New Zealand Pension Fund manages $30 billion in assets, embraces the concept of sustainable investment, and integrates responsible investment as a core principle of the fund, and believes that responsible investment can increase revenue and reduce risk in the long run. In 2006, the New Zealand Pension Fund became a founding member of the United Nations Principles for Responsible Investment and used a responsible investment philosophy in its portfolio to consider environmental, social and governance factors (ESG). In 2007, the New Zealand Pension Fund launched a responsible investment framework. In 2015 and 2016, the New Zealand Pension Fund completed a benchmark assessment of the United Nations Principles for Responsible Investment and received an A or A+ rating in eight reporting categories. In 2015, the New Zealand Pension Fund also released a white paper on responsible investment, which will continue to be a model for sustainable investment practices.

The $450 billion Dutch government pension was negotiated in mid-2000 and required a systematic approach to assessing the sustainability risks of real estate investments. But one problem with its real estate portfolio is that it has to rely on individual investment managers to track sustainability indicators, making it difficult to effectively compare real estate and explain the risk factors embedded in the portfolio. To address this concern, the Dutch government pension, in partnership with Maastricht University and other funds, hopes to create a standard way to measure non-financial and sustainability risks in real estate investment. In 2009, thanks to their efforts, the Global Real Estate Sustainability Standard (GRESB) was created, and since then, hundreds of institutional investors have been using this standard.

In fact, although many sovereign wealth funds/government agency pensions have adopted the concept of sustainable investment, there are still many funds that have not incorporated sustainable investment ideas into their investment processes. No institution is willing to invest in companies that exploit workers, pollute the environment, or engage in unethical behavior. However, many organizations have been slow to develop when it comes to incorporating sustainable investment criteria into the investment process to mitigate this risk.

Reporter: Why are many institutional investors less willing to adopt sustainable investment?

Scott: There are three concerns for investors: first, confusion about language and standards. While information quality, reporting, and access to resources have improved significantly over the past decade, there are many confusions about multiple standards, guidelines, and implementation strategies for sustainable investment. Lack of consistency standards has made it difficult for large asset allocation agencies to manage and measure sustainable investments. In addition, many investment institutions use proprietary, sustainable investment frameworks to create funds, and are more complex for investment institutions that have to rely on external investment managers to track sustainability indicators.

As a non-profit organization, the New Bretton Woods system encourages investment institutions to invest in sustainable investment and launches the “Sustainable Asset Allocation Index”. By providing a consistent, unified set of principles and standards in this index, the New Bretton Woods system hopes to drive more investment into sustainable investment practices.

The second concern is that sustainable investment can drag down performance returns. Many investment institutions are unaware that the academic community has eliminated this concern in the past decade. In 2012, a study analyzed more than 100 research papers on sustainable investment and found that 100% of research papers consider companies with high environmental, social, and governance (ESG) ratings to be less risky. The study also showed that 89% of companies with high environmental, social and governance (ESG) ratings have a high return on investment. Another study published in 2015 analyzed 2,200 related research papers, of which 2,100 showed that companies with high environmental, social, and governance (ESG) ratings were positively correlated with outstanding financial performance. These studies confirm that in the long run, adding sustainability criteria to portfolio choices will not only reduce risk, achieve excess financial returns, but also achieve important social benefits.

Institutional investors are beginning to realize this. A recent survey of 600 investment institutions showed that more than 50% of respondents expressed disagreement about the consideration of environmental, social and governance (ESG) factors that meant missing investment income.

The third concern is related to fiduciary responsibility. Asset configurators are concerned that introducing a sustainable investment risk into the investment process will be inconsistent with fiduciary responsibility. In order to protect the interests of shareholders, many investors believe that the trustee should only consider traditional financial indicators when making investment decisions. As a non-financial indicator, sustainable investment factors should not be considered. Even more worrisome is the fact that adding a sustainable investment factor to the investment process may result in fewer options for risk diversification.

These concerns were resolved in the second half of 2015 by regulators in the US, UK and Europe. Factors that consider sustainability can be seen as an integral part of fiduciary responsibility.

Scott E Kalb is the founder and CEO of KLTI Advisors. KLTI Advisors is a consulting firm dedicated to helping institutional investors make long-term investments, often working with sovereign wealth funds and government pension funds. Scott E Kalb also serves as Chairman of the Sovereign Investors Association (SII), a member organization that brings together sovereign and government funds from around the world. SII currently has 245 sovereign and government fund members from 50 countries. In addition, Scott Kalb is a senior consultant for the new Bretton Woods system.

From 2009 to 2012, Scott E Kalb served as Chief Information Officer (CIO) and Deputy Chief Executive Officer of Korea Investment Corporation (KIC, Korea Sovereign Wealth Fund) and became one of the few people able to manage sovereign wealth funds in other countries. During his tenure at Korea Investment Corporation, the assets managed by Korean investment companies grew from $19 billion to $60 billion. Prior to joining Korea Investment Corporation, Scott E Kalb worked in the financial industry for 25 years. From 2006-2008, Scott E Kalb was a Senior Investment Manager at BA lyasny Asset Management. From 2002 to 2006, he served as CEO and Senior Investment Manager of Black Arrow Asset Management. 1999-2002, Senior Stock Investment Manager at Tudor Investment Corp. Prior to this, Scott E Kalb spent 10 years at Citi, where he worked in international equity research (1990-1995) and served as managing director of the International Assets Department (1995-1999).