Podcast: Why the research that backs sustainable investing takes tenacity

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Male voice: This podcast is for professional investors only.

Erika van der Merwe (Erika): The wave of inflows continues into ESG-focused strategies and impact-targeting strategies. But what lies behind the impressive product labels and glossy marketing materials? What does it truly take to identify the right assets and to build sustainable investment portfolios?

Male voice: Welcome to a new episode of the Robeco podcast.

Erika: Rachel Whittaker is our guest to discuss the latest thinking in this field. She's Head of SI Research at Robeco. Welcome, Rachel.

Rachel Whittaker (Rachel): Hi, Erika.

Erika: Rachel, you've been in sustainable investing, so ‘SI’, for many years. What changes have you seen over the years and would you say that there's been a major shift recently?

Rachel: There has certainly been a lot of change over the last 15 years, and particularly so in the last few years, we've seen a real acceleration. There are a few really notable things. One, of course, is the level of interest and demand for SI products, as you mention. We've seen unprecedented inflows in the last few years. And alongside that, that demand has been met with much more interest from the investment industry in providing a range of sustainable investment products to meet the needs of a wide variety of investors. And the positive side of that is that SI is no longer a niche activity, and investment institutions are putting their best minds to work on the job. So that growth has only had a positive outcome on the quality of the products that are available. But the downside is that it has led to a proliferation of products that have a rather weak basis or very little true sustainability input. And that creates a lot of noise for investors to wade through when they're looking for products that meet their individual needs.

But we've also seen a broadening of the scope of sustainable investing. So I moved into this space from more traditional investing about 15 years ago, and at the time, environmental-themed investing was just taking off. And we were seeing a clear movement away from more ethical motivations for coming to this area of investment and a growth of the idea of ESG integration, and incorporating information and opinions about environmental and social issues into investment decision making, even when the investment philosophy wasn't fully focused on building sustainable portfolios. That movement towards ESG integration was advocated by the UN PRI and the growth in commitment to the Principles for Responsible Investment has also been one of those drivers of growth over the years, as more and more financial market participants have made a commitment to the broader topic of sustainable or responsible investing.

Erika: You mentioned those challenges. So I would also imagine that, as a business, you're having to meet this demand quite rapidly and in many ways while simultaneously having to break new ground. That means gathering the right data, ensuring all the methodologies are in place and that they're rigorous and, of course, that you’re reporting on it all. How does one balance all of this and make sure you do it well? But before you answer that, here is your CIO Victor Verberk. He was talking about the need for innovation in SI, as well as the lack of visibility that asset managers have as they invest for climate and sustainability.

Victor Verberk: You have to embrace that. We have to do technological inventions and we need to have lots and lots of IT. SI IT, I always say. Data management, so there's a lot to fix. But there's also a bit of time to do so. So as long as Robeco is a year ahead, on biodiversity we are, for example, now working very hard, then we will be ready for the changes. And the changes will come. If you as an asset owner are too late, then you get stuck with the stranded assets and the bigger tail risk. You will have evaluations on certain companies that are behind. So if you have a little bit of confidence that the policymakers sooner or later get it right and will start pushing, then you need to be slightly ahead and not slightly behind.

Erika: Your response to that, Rachel?

Rachel: One of the things that we've seen over the last few years as the industry has grown, is that we've seen a shift in the kind of roles that are available for people focused on sustainable investing. Fifteen years ago, if you were an SI specialist, you were very much a generalist. You did a little bit of everything, probably a bit of research, a bit of sales, a bit of product development. What we've seen now is that this is far too much for generalists to be involved in all of this, and we're seeing much more of a need for specialist investors to start incorporating a focus on sustainability into their jobs. So, yeah, we're responding to all of these different drivers of sustainable investment. And that means that we need to bring in all of the specialists from around the organization. And it's very difficult today to actually have a job in investment that doesn't in some way, you know, have some influence from sustainability.

Erika: Rachel, what I'm hearing then, is there's so much change happening in the field of sustainable investing, and the solution is to have this specialization in order to cope and perhaps in this early stage, to have a competitive advantage. Do you believe that? Do you believe that you need that specialization to be ahead of the pack?

Rachel: I think across the industry, specialization is certainly where we need to go to keep moving the area of sustainable investing forward in a meaningful way. That we're creating products that genuinely are investing in sustainable industries and sustainable companies, or creating impact that meets all of the growing needs for regulation. From an SI research perspective, for us, being a specialist team makes sense, given that Robeco is a research-driven organization. So our approach to being sector and industry-specialist researchers is entirely in line with our organizational values and our overarching investment philosophy, anyway.

Erika: Can you take us deeper into those practicalities, because it just seems, you know, a black box, as I alluded to earlier on. You've got these inflows and you've got these wonderful product labels and lots of green in the imagery. But what do you actually do? How do your analysts gather information?

Rachel: Because we are a team of industry specialists, while we do have some common topics that we all look out for in every industry and some common tools and resources that we can all use, the same kinds of tools and resources that are available to many of our peers, standard data, standard research reports, every analyst in my team has the freedom and even the responsibility to go and seek out the information that they think they need to really understand individual companies and the sustainability drivers for that industry. And that information, that data, that's going to be different for each industry; it might be different for different countries. And they are free to go and seek out where they can find the most insightful sources of information. We don't want to be using exactly the same sources as every other asset manager in the industry. This is where we see our competitive advantage. So, for example, large companies in developed countries tend to be very well researched anyway by standard research agencies or broker research, and they may be very transparent anyway in their own reporting. But for smaller companies, companies in emerging markets or even private companies that issue debt but not equity, it's much more difficult to find that public information. So by having a team of analysts who are so focused, they have the time and the resources to dig much deeper for the information that they need, more time to maybe talk to the company directly and to look for alternative and non-traditional data sources, talk to our colleagues and regional offices about the trends that they see going on in their country and so on. So that's where we think we can add value to the investment process.

Erika: So it's about the information, about ferreting out the new information that your peers don't have, not just relying fully on data providers.

Rachel: Yeah, absolutely. And I think, the fact that Robeco has invested in a team of industry sustainability specialists is a differentiator. Many of our peers still have much smaller teams of SI analysts. Or maybe they've incorporated ESG analysis into their more traditional equity or fixed income research teams. Now there's no right or wrong way to do this, but realistically, there is a limit to any single person's expertise.

Erika: But what does your team composition look like and what are their specific skillsets that you look for? I mean, just looking at your own profile, you've got this interesting mix of skills and qualifications. You've got a degree in anthropology as well as the Chartered Financial Analyst accreditation. Is that also the kind of composition you're looking for in your team?

Rachel: Yes. I think the ideal SI research analyst would have some specialist industry knowledge, they would have financial analysis experience, they would have investment understanding, they would have sustainability knowledge, and they would also have great communication skills. As you could imagine, it's quite rare to find. There are people who can do all of those things brilliantly. So we have a range of people within the team who come from all different backgrounds. Some come from academia and have amazing research skills, maybe have dug into some sustainability topics in great depth. We have people who come from corporations within the industries that they follow, so they have great networks of people they used to work with who can help them understand the latest trends or new innovations. We have people from an investment background who really understand how investment teams work and how portfolio managers think. So what we have to do is try to make sure that we share those skills across the team and that the team as a whole has the good balance of skills because it's a lot to expect any individual person to be able to do all of that. But that's certainly the goal as our SI analysts progress along their career path, that they will have that very broad skill set and excellent understanding of both the investment implications of sustainability issues, but also really understand the science or the social issues behind the ESG issues that they are looking at.

Erika: And what's the interplay, the connection point between your team, the SI analysts and the equity analysts and the fixed income analysts. And who wins at the end?

Rachel: Yeah, that's one of the biggest challenges for us. Because when you get this specialization across the value chain, then the communication between the different teams becomes the most difficult part and the piece that if you lose that, then it doesn't matter how great your analysts are because you're not going to get that information into the investment decision in the end. Ultimately, in any investment process, the portfolio managers make the ultimate decision. But the sustainability analysts are there alongside equity analysts, alongside fixed income analysts and presenting our ideas for how sustainability drivers are going to impact the investment case going forward. But communication is absolutely key, both between us and the analysts, between us and the investment teams, between us and the Active Ownership team. The ones who are exercising the proxy votes and engaging with companies. We need to make sure that we share our insights and collaborate with the other teams across the organization. So that means not just quietly writing reports in our corner of the office, but proactively having conversations and discussing with our peers, making sure that we are getting our message across outside of the more structured process of publishing reports.

Erika: Switching focus slightly. So, another new development for asset managers is the increased regulation in the area of sustainable investing. What are your views on this, on the ideal role and place for regulation in SI?

Rachel: Well, I think you really know something is mainstream when the regulators start to look at it. So it's a very positive thing that now we are in the focus of the regulators, and it's certainly bringing big changes for sustainable investing. I think we've seen the most progress over the last couple of years in Europe. The aim of the European regulation is to create more transparency, standardization and all with the goal of ultimately protecting investors. But there's still quite a lot of uncertainty around the implementation. A lot of the guidelines require a lot of interpretation, so that's created a lot of work for financial market participants, and we're now starting to see other regions introducing their own frameworks. So there's some risk of conflicting frameworks for global organizations, but in practice, what we're seeing is that many other regulators are looking to what's been done in Europe, and they're looking at those best practice frameworks to decide how to shape their own rulebook. But you know, in my view, one of the biggest risks of increased regulation is making sure that it achieves its aims of protecting investors without stifling that innovation that Victor was talking about. And in the case of sustainable investing in particular, it has to achieve its aims without detracting from that essential focus on real-life outcomes. Ultimately, the goal of SI is not just to achieve financial returns, it's also to drive positive change. And we don't want it to become a box-ticking exercise that's focused solely on reporting or on backward-looking metrics, or just on having the right disclosures in place. We have to balance that need for regulation and for investor protection with the goal of directing capital to the areas where it's going to make a real difference to achieving the Sustainable Development Goals.

Erika: Could you give an example of that? So if I understood you correctly, what you're saying is all this regulation might take so much energy and focus for the asset managers, just making sure you’re complying, that in the process you are sucking up resources and not focusing on innovative solutions. Could you give examples of some such innovations?

Rachel: One element of it is the resources that are required to actually deal with the regulation. And certainly, many asset managers and banks have found that they've had to quickly train up many of their legal and compliance people in what is sustainable investing, adding new skill sets to areas of finance that previously didn't have to deal with it. But another issue is how prescriptive the regulation wants to be. How strictly do you want to define what activities are sustainable or what companies are sustainable? Because what we've seen over the last, not just the last few years, but going back, you know, 10, 15, 20 years, is that new areas of sustainable and impact investing have emerged. We have microfinance. We have private equity investors coming to impact investing and wanting to incorporate environmental and social goals into their investment processes. And we have different sustainability needs in different parts of the world, different priorities between different industries. So when you create the regulation, you have to make sure that it's strict enough to deliver transparency and for investors to understand what's going on, but not to try and limit the scope of what is sustainable investing and effectively rule out new strategies that might find new ways, new product structures or new ways of addressing critical sustainability topics and creating those investment opportunities for investors.

Erika: With the growing demand for ESG, SI and impact-related investment products, we're also seeing a lot of discussion around the risk that this could lead to bubbles in certain asset categories or sectors, and I'm sure you get asked this a lot by clients and at conferences where you speak. Should we be concerned about this?

Rachel: That is a question that comes up a lot, and in recent years it's been: is there a bubble in sustainable investing? But, even before we saw this very rapid acceleration, the question was always: Oh, do you have to sacrifice returns to invest sustainably? So it's almost a different variation of that same concern because my answer is very similar. Investors always need to be conscious of valuation, and that doesn't change with sustainable investing. We don't prioritize sustainability issues over our fiduciary duty or over the traditional valuation frameworks in the ways we've always looked at investing. Robeco as a whole needs to, our investment managers need to look at companies through a financial sustainability and evaluation lens. With any major trend, there's always a risk that certain assets become the focus. And if everyone had the same definition of what is sustainable and which companies will benefit, then of course there's a risk that some investors pile into those assets. And again, that's why we don't want regulations turning the SI industry into a group of identical-looking products. We need to encourage innovation in financial products to keep finding new ways of moving capital to where it's needed, but also as a way of finding new investment opportunities. So our role as analysts and as asset managers is the same as it's always been. We're trying to identify the companies that are going to be leaders. That are going to be winners in a sustainable future. But we have to do that with the same investment rigor that our portfolio managers have always employed.

Erika: Rachel, sort of related to that: do you believe there is a sustainable alpha? Can you earn alpha from this focus?

Rachel: Again, I have to wonder if we're asking the right question, because we also ask that question of active management. Can active managers earn alpha or should we all just invest passively in the whole market? The question is really: do we trust the investment process? Do we believe that the investment managers that we choose have the skill and the resources at their disposal to do what they say they're going to do? And that's the same for sustainable investing products as it is for our products without that label. We have thematic investment products that don't necessarily have anything to do with sustainability. There are lots of different approaches to investment, and sustainable investing can add value. It can create alpha if you have a process that is going to deliver better insights, if it's alongside good risk management, if it’s alongside rigorous processes. On its own, just looking at sustainability issues isn't necessarily going to deliver you anything special. It’s all part of a whole package.

Erika: Rachel, in closing, we've seen countries, businesses, investors all backing the Paris Agreement. What will be our biggest challenge in getting to net zero by 2050?

Rachel: Well, that's a question that we could have a whole conversation on. There are certainly people who are better qualified than I am to talk about how we get to global agreements and whether we have the right technologies in place. But if I think about this from a sustainable investment research perspective, there are some obvious things that Robeco can do to move towards being a net zero investor. But perhaps the more difficult question is how we incorporate our net zero goals into all of our investment decisions.

So within SI research, one of our aims is to understand the challenges that specific industries and individual companies face from the physical risks of climate change, and also from the transition risks of moving towards a net zero economy. So we’re trying to understand how companies are planning to tackle these risks and what impact their business decisions in response to these shifts will have on the company's future growth and profitability. And we look at that for all of the companies that we cover. Climate change preparedness is a core topic for every industry that we look at, because no companies are immune from at least some degree of physical risk from climate change somewhere in their value chain, or the transition risks from changing regulations and changing technology. And for some industries, the potential market opportunities that would come as a consequence of our efforts to mitigate and adapt to climate change.

So, for example, in the consumer industry, some companies might see rising raw material costs or they might see risks to their physical risks, their operations, like if they have factories in water-stressed regions. But they might also find new demand for certain products that can help consumers adapt to climate change or to reduce their own impact. Like the consumer goods companies selling detergents that work in cold water so that you don't need to use energy to heat the water, or soap that doesn't need as much water to rinse it off.

So there are lots of ways in which companies can be addressing climate change and the challenges that we face as analysts in trying to evaluate that for individual companies, partly from, the availability of data on companies’ own carbon footprints, even where companies are very diligent and transparent in measuring and disclosing their direct and indirect emissions. Not all companies could do that and even those that can, if they have products where most of the product-related greenhouse gas emissions are mainly in the value chain, maybe in the sourcing or in the end use, it's very difficult to try and measure and to influence those emissions. So trying to understand those impacts on companies requires a lot of knowledge of whether the companies are well-positioned enough to try and influence their value chain, knowledge of the industry to try and understand what impacts a company can have, even if they're not really disclosing or measuring those themselves. So we really need to dig into the disclosures from companies and what's going on in the industries as a whole, understand what the peer group is doing, to really try and evaluate whether companies have the right knowledge, the right technology, the right management to meet the kind of climate ambitions that these companies are talking about.

Erika: Certainly huge challenges ahead for you and your team, Rachel. All the best with that and super talking to you. Thanks for your time.

Rachel: Thank you, Erika.

Erika: Thank you for listening to our podcast. We'd love to hear from you. So please do send us your comments, feedback and suggestions. You can send those to podcast@robeco.com and you'll find all our podcasts on your favourite podcast platform, as well as at robeco.com.

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