SI Opener: Let’s be clearer about what ESG integration actually does

Due to scrutiny from regulators and the need to become more precise in the wording used around sustainable investing, a recent Bloomberg article¹ suggested that some asset managers have stopped using the catch-all term ’ESG integrated’. I am strongly against this, but would argue that the phrase should be used in the right way, as the Principles for Responsible Investment (PRI) has done for over 15 years .

Instead of throwing away the baby with the bathwater and stop talking about ESG integration, I think it is important to analyze why this is even suggested. I think one of two things is happening.

• ESG integration is used to imply that investment strategies are sustainable, which is not always the case.

• Investors have said they integrate ESG, but they cannot prove that, so it has led to greenwashing.

As I wrote in my column on greenwashing in 2019², structurally integrating ESG information into the investment process helps our teams make better decisions. It does not, however, reduce the universe, and our portfolio managers are still allowed to invest in companies with low ESG scores, so long as they believe the risks are more than priced into the market.

This method of integrating ESG, although infinitely more difficult and profound in its application than only using ESG scores to reduce the universe, is often not categorized as a sustainable strategy. Clients who want to invest in sustainable or impact strategies simply do not want to invest in ‘bad’ ESG companies, even if this is already reflected in the share price. So I would argue that we should keep on referring to ESG integration, but in the correct way that it is described here.

At Robeco we explicitly integrate ESG into our valuation work on the equity side, into our fundamental scores on the credit side, and into our country reports for our sovereign investments. Because this is all reflected in our investment cases, we can actually prove that we structurally integrate ESG. A quality control is also done on these cases to make sure that our approach is meaningful. We have even tried to show the added value of our approach.

Proving that it works is a question that is often asked, but is difficult to answer, as ESG integration is like putting sugar in your tea. After stirring the cup you cannot distinguish between the tea and the sugar. It only tastes better. You can also no longer separate the sugar once it has dissolved. I can imagine that this also applies to ESG integration. if you claim to take ESG into account in investment decision making, but keep no records of the impact on your valuation, or fundamental assessment, it is difficult to prove that you put the sugar in. And therefore it will be more difficult for you to talk about ESG integration.

More scrutiny on how sustainable and impact investment strategies really are, and specifically greater transparency about what is actually being done and not done in the investment process, I believe is important and warranted. The EU finance plan in that respect is doing its work. It uses the concept of double materiality. This concept is far from new and goes into the purpose of sustainable and impact investing.

The ‘why’ should, if you ask me, always be at the heart of any sustainable investment policy. Are we trying to achieve better investment performance? Do we want to avoid investments for reputational reasons? Are we trying to change the world, or is it all of these things? Only once this is established can the question be answered as to how to implement it. To make better investment decisions, ESG integration is the tool. But it is not a tool to change the world, or to avoid making a negative impact. In the graph below we explain the difference. Between ESG integration and impact investing, where there is a clear intention to add a societal value.

Finally, ESG integration as commonly defined is simply done for financial reasons. Sustainable investing, on the other hand, can be done for multiple reasons. Some clients simply do not want to invest in controversial areas of business or controversial companies. They’d rather invest in companies or countries that have good track records in sustainability.

Others want to profit from sustainable development by investing in companies that create solutions for certain sustainability issues such as climate change, inequality, or improving health, etc. Or they intend to create a positive impact. These goals are tied to impact investing. As the goals of the end investors can be different, there is room for multiple strategies to exist alongside each other. As an asset manager with clients globally, we need to offer our clients funds and solutions that fit their needs.

However, the overall bar is being raised all the time, and what is deemed sustainable now might be deemed unsustainable in the future. So, we need to continuously adapt our standard offerings with new areas of exclusions, new engagement themes, and raise the thresholds in our framework for contributing to the Sustainable Development Goals (SDGs). This leads on to real sustainable and impact investing, and not what some people think it is.