Sustainability - Less Public Commitments, More Delivering on Objectives

Speaker A: Hello, everyone, and welcome to the Sustainable Finance Podcast. My name is Paul Ellis and I'm your host for these programs about developments in this fast growing industry. Sustainability has moved out of the asset management limelight over the last few years. Faced with more political pressures and conservative policy agendas in some countries, firms in the investment industry are experiencing slower flows into sustainable funds. Even in Europe earlier this year. Schroeder's has been a leader in sustainable investment for almost 30 years, featuring dedicated sustainability career experts across asset classes, markets and countries. And today we're speaking to Andy Howard, who heads sustainable investment globally at Schroeder's for his take on where we are, where we're going next, and what Schroder's is doing to continue to expand its leadership role in sustainable investment opportunities through active management and engagement. Hello, Andy, and welcome to the Sustainable Finance Podcast.

Speaker B: Hi, Paul, it's great to be here. Thank you.

Speaker A: Yes, we're gonna go right into the questions we have because we've got a lot of ground to cover this morning. And um, it's, you know, this is a, uh, really interesting year that we're in now for sustainable investment, so let's just dive right in. Um, Andy, how did we get to a point where the investment industry, having made sustainability a focus of its messaging for many years, has gone more quiet regarding topics like net zero goals?

Speaker B: Well, it certainly has changed a fair bit over the last few years, as you say, Paul. And it's something that we look at very closely and we try to keep an open mind about why this is changing and what that means. We've got a slide, actually one of the slides that tries to plot this over time. What we've done here is to look at global news flow. So this is looking at news stories globally, um, on the topic of sustainable investment. And it's combining two things. One, the volume of news on sustainable investments and then two, the sentiment of that news. So is it more positive or negative? And the higher up the chart you are, the more news there is and the more positive it is, and vice versa, I think you can see a couple of things. One, um, there was a bit of a period a few years ago where it got pretty peaky. Um, if you go back to 2021, 2022, it was getting pretty high and there was an awful lot of focus and there was an awful lot of noise, um, around sustainable investment within the industry. And then secondly, obviously then more recently, um, that has come down. But I say the other thing that one notes from this is that the trend is sort of fairly firmly upwards over the last 10 years or so that we can actually measure this. And I think there's the two things. There's an upwards trend that is still, in our view, going to keep on moving in that direction, but there will be cycles, phases and changes within that trend. I think that's what we're starting to see at the moment. The reality is we are at a time where you go back to 2021, I think it's, uh, quite remarkable, but you've got over 12% of the investment industry's total advertising spending was on globally or was on sustainability and ESG topics. It's well under half that number today. And that period where it sort of felt like, as you sort of alluded to, every asset manager had pictures of icebergs on their website and it sort of felt like, um, everyone had sort of become focused on sustainable investment, sort of got a bit, a bit too carried away potentially. Um, and I think we've been through obviously, something of a right sizing the period when you had frankly half the world's asset management industry signed up to industry initiative like the Net Zero Asset Manager Initiative or climate action 100 plus. I struggle to think that more than half of the world's industry was that focused on and committed to sustainability, um, at that point in time. And so things have shifted a little bit, partly as a function of the political change, partly as a function, I think, of more focus on greenwashing, um, in many parts of the world, and also partly because I think it's getting easier to explain what we're actually doing to many of our clients, rather than relying on high, um, level advertising or membership of different initiatives or organizations to try and demonstrate how we're approaching this.

Speaker A: Yes. You know, Andy, in my experience, the last few years have been, um, in part about language, uh, and also in part about investment strategies. And that seems to be the way that these processes filter through and populate the industry as a whole. So is sustainable investment a fad or phase whose time has passed?

Speaker B: Well, predictable answer, I suspect for me, but I. Look, I've been in this area for about 20 years. We've been through lots of waves and phases and I sort of find it quite interesting in the. I'm not sure whether to say it's sort of good or bad really, but it sort of feels like at some point over the last five or six years or so, the rest of the industry sort of caught up to what we've been doing, or I've been takes early for much of the last 20 years. Um, so now look, I don't think it is by any means a fad or a phase or some sort of short term fashion that's now going out of fashion. Um, but I do think that there is a slightly different kind of shift. We're going into a different phase, a different era, if you like, within sustainable investments. We've been through different areas at different points in time historically. Um, so personally I sort of come back to the fundamentals of this.

Speaker A: Okay.

Speaker B: And the fundamentals aren't um, really changing that much. And the reality is that in terms of real world change, um, the challenges, the opportunities, the disruptions are only growing. You've got about a 50% higher level of physical damage caused by climate change over the last decade relative to the decade before that. You've got to a point now where more than half the world's population in developed economies is dissatisfied with the political system. You've got levels of social discontent and mistrust that are at record levels. These aren't going to solve themselves because we stop talking about sustainable investment. These are underlying challenges that will inevitably have an impact on the way we manage capital. Um, and if you look at companies, I think they're still very focused, um, on sustainability for the most part. If you look at how that's shifted over the last 10 years, um, say for example using the World Economic Forum, which does an annual risk survey, go back 10, 15 years, nothing much in the top five or 10 risks was related to environmental or social topics. Now environmental and social topics dominate that list. So the kind of the real world change has happened. I think the or is happening. Um, companies have continued to become more focused structurally on these topics over time. And the reality is as well that what we see from our clients, certainly on the institutional side of things, is that there's still a lot of focus. If you look at the world's top 100 asset owners, more than half of them have got public commitments, um, around different aspects of climate change or sustainability within their public statements. I think we have a slide on that which really just looks at again our analysis of the top 100 asset owners by size globally. Um, and you can see there that the proportion of those asset owners globally, this is the world's big pools of capital, um, in the institutional, uh, world that have got some form of climate commitment is still very high. And if you look at the way that that's changed, um, over the last 12, 18 months or so at the margin, if anything, it's become relatively More ambitious rather than less ambitious. So you kind of put these things together in terms of the real world change in terms of the shifts and the focus that we see within a large part of the corporate world. And then you look at our clients. I think the reality is these issues aren't going anywhere. Um, what is shifting is I think this shift from whether sustainability is a sort of generic concept is going to be important to how are you approaching this in practice? What does this actually look like? I think there's more focus, quite correctly is going into really trying to understand how our different managers, how are different investment strategies approaching sustainable investment and how does that relate to, to performance goals, um, that different, uh, different of our clients have. Um, so look, it's going to look different. It might even have a different name. We're not desperately good at uh, coming up with names for things, but I can see there's lots of names that are being suggested for how we might change the terminology from sustainability to other words and we may well end up doing something ourselves. But the reality is that's the underlying fundamentals of what we're talking about are only becoming more important. The challenges of how you do that are becoming more nuanced. Um, but um, the opportunity I think is as strong as it ever was for the clients that have got that more forward looking perspective.

Speaker A: Okay, well that's good to hear. And um, uh, what we want to do now is zero in on um, Schroeder's uh, uh, focus on sustainable investment. And what is that? What does it mean to your firm, to Schroeder's? And are you redefining the firm's sustainable investment goals at this point or sticking with the things that you've been, that have been successful for you? Of course in terms of investment strategy, but in terms of defining them and then the language that you use to describe them.

Speaker B: Um, so I mean to us sustainable investment is really about connecting capital to real world changes. The way changes that we see playing out in the real world. Social and environmental shifts that are increasingly uh, disrupting economies, industries, investments and the portfolios that we manage. Um, to make sort of make it a slightly personal. If I started out as an Investment Analyst Almost 30 years ago, I keep, I was still old when I try and date these things. Um, had an awfully long time and I was a mining analyst, um, covering global mining companies. I used to go and visit mining companies and they would insist on spending the first 10 minutes or so talking about health and safety and what they were doing with local Communities. And even then it was clearly important. We didn't have a name for it, we didn't call it sustainable investment at the time. As an analyst I'm sat there thinking this is clearly important to the person running this mine. It's usually a man, um, running, running a mine somewhere in the world, um, but I don't know what to do with this in my investment decision making. I don't know how to put it into my model. I don't know how to consider this when I'm trying to look at how much this company might be worth. And what became clear to me was that there was this gap between what we were doing within the investment industry in terms of trying to understand businesses, um, and how much they were worth and what made them successful, which was mostly staring at annual reports, financial statements and trying to work out how much money a company might make this year and next year versus the things that within businesses were just intuitively obviously parts of what it meant to run a successful, healthy company. And really to my mind the importance of bridging that gap has only got stronger as many of those challenges on a macro level, whether it's around say environmental issues or social issues have become more important, important. We've seen more regulation in those areas and the importance or uh, the opportunity similarly to bridge that gap with data and analysis has become much more mature, much more robust and ah, much more possible than it was in the past. And I think therefore that when we think about what is sustainable investment, it's really about connecting those two things. It's about casting a wider net in how we look at companies and how we connect say the investments that we manage to an understanding of what's changing in the real world, which is very much really just an extension of active management, um, which is very much at the heart of providers and our DNA. A belief that simply investing in the world as it has been for the last few years is going to be unrewarding in a world that is becoming more fast changing, more fast moving and where a forward looking view is becoming more and more important, um, as a result. So in terms of our approach, no, it's not really changing in terms of redefining the goals, the strategies, the objectives. And I should say as well that we don't really have sustainable. This might sound a bit weird given my job title and I'm not meaning to do myself out of the job, but we don't really have sustainable investment goals. Our goals are really grounded in delivering for our clients and that's not Changing, I don't think that'll ever change. Um, we're very aware that we're not here to promote sustainable investment as a field, as a philosophy. We're here to identify the factors that we think will influence portfolios in the future and um, to build portfolios for our clients that help them to meet their objectives. And we're very aware that how we invest and how we do that is getting more complicated. So not redefining objectives, objectives, goals. Um, but I think certainly where we're focusing our attention is shifting slightly. First of all, in terms of which issues do we look at? Um, not every sustainability issue is an equally important or powerful investment driver. Um, the reality is that some areas have got a higher level of social or political scrutiny and therefore have more financial relevance in some areas, perhaps more likely to play out over the longer term. And so it's about being focused on the right topics, those topics that are moving into and um, becoming more financially material. It's about how you approach those areas. So rather than, I think, where a lot of the sustainable investments industry has been for much of the last, um, many years really, which has been defining sustainability based on the characteristics of a company. So you have a sustainable portfolio comprises companies that are already sustainable, whether that's ah, low carbon or with good ESG ratings or whatever else it might be. Um, where I think we're seeing more focus and certainly we're putting more focus is on how do we think about the outcomes that those companies and those portfolios deliver over time. So rather than thinking about solely which companies are low carbon today, thinking about which of those companies or investments that are decarbonizing over time, and as companies improve, as companies transition, they can unlock value. So if we look at this over the last, say five years, for example, companies that have been able to decarbonize most quickly relative to their sectors have outperformed companies that have done the least quick or the slowest rate of decarbonization by about 4% a year. Um, so there's a real opportunity there to connect sustainable outcomes and investment outcomes. Um, in that transition framework. The problem is it's pretty hard because it's pretty straightforward to figure out which companies are low carbon companies today or which companies are more sustainable companies today or at the end of last year, it's an awful lot harder to work out who those companies will be over the next five years. Um, and that's really, I think, where the integration of analytical capabilities, fundamental insights into those companies, and then really critically active engagement. So working with and engaging with management teams to support those management teams on the journeys that they identified as being the most valuable, um, sustainable strategies for their business is really critical. And we've got a slide on that, again, showing our experience at Schroeder's on this over the last few years. Um, and that slide just shows the way in which, if I take the MSCI acquisition of an index of global companies and then split it up into companies that, um, we did engage with and companies we didn't engage with, you can see that the ones that we have engaged with have been about twice as likely to set a new emissions reduction target. They've cut their emissions about twice as quickly. And, um, really importantly, they have also outperformed relative to the companies we didn't engage with. So, again, it's a specific data set in a specific period of time. Um, but the reality is similarly that it can unlock value and it can create better performance outcomes for clients where we do that effectively.

Speaker A: It's really good to see the tracking of the data that you're displaying for our audience, Andy. And that's one of the things that I talk to people about every single day. And, um, the key, uh, I think in all of this, obviously over the longer term, is what you're hearing from your clients. So how is that going? How are you, how's the interface with your clients going related to, um, this type of focus for them in their portfolios and for the industry as a whole, with Schroders at the head.

Speaker B: Yeah, look, and I think, I mean, that's exactly your point on data. I think it's really important that we view the world as it is, not the world as we might like it to be. I think one of the areas possibly where parts of sustainable investment have run into some challenges over the last few years is where you try and think about the world as you would like it to be, rather than necessarily the world as you actually see it. Um, and the reality is, hence my sort of point at the beginning, that we are seeing the shift and we have to have an open mind about are there areas in which some of the criticisms at times, um, challenging and difficult to hear? Where are there valid elements to that and where are there less valid elements to that? Um, but to your question on clients, um, there's no simple answer. I always find it quite interesting as they sort of clients have never been a homogenous group of clients. They're all different. Um, and that's becoming, I think, more and more true. Um, there's a Bit of a tendency oftentimes to sort of paint this as a transatlantic divide of North America or the US and Europe as being on sort of two entirely separate ends of the coin. I don't think that's quite right. Um, some of the most thoughtful, engaged, ambitious clients we have are in the U.S. um, and similarly, um, some of the less genuinely engaged and thoughtful clients also sit outside the US So it's really a global shift. And I think what we're seeing is this, if you like, more fragmentation. As this field of sustainable investment has matured, I think we're seeing different organizations one figuring out that there are different areas that they focus on. So for some organizations it's really all about climate change. For some organizations there's as much of a focus on diversity in some cases, or nature or human rights all play different roles and these are really different topics. So what does sustainability mean to different clients? Very different. How are they going to go about investing in that area? The game can look very different and some organizations have got very specific sustainability objectives, e.g. reaching net zero or decarbonization or investing in specific solutions, um, that deliver sort of positive changes in the world. Um, and some organizations are much less focused on those topics. But the one thing that brings them all together is pretty much is a desire to generate returns, to generate investment performance for their beneficiaries, um, of whatever type, over whatever time frame. And so I think whilst we see that yes, there are things like net zero targets and goals, the focus on M, the trade offs, the questions about how does this impact the way that the performance that we're going to deliver has become a much sharper focus over the last few years. So that's not to say that we're seeing organizations walk back, but again it goes back to that point of the focus on how do we do this, how do we achieve our complete set of objectives in a way that it mitigates the trade offs that avoids just simply thinking about sustainable investment as a constraint, as a limitation on what I can own, but rather thinks about it in terms of how do I capture the value that can really be unlocked through transitioning through change is a shift that we're starting to see from a lot of investors around the world. And I think that's really positive because the period of time where in a way we sort of feels to me like the bits of the investment industry sort of lost sight of why we were doing this in places. We started looking at climate change 10 years ago, longer personally, and certainly it showed us for at least the last 10 years. And we didn't do it because there was a, uh, net zero asset manager initiative or any other common targets floating around. We did it because we could see that there were growing risks that it was going to become increasingly important for us to think about proactively in the way that we built and managed portfolios. And we really focused on that sort of risk and opportunity question from an investment perspective. And at some point a lot of the industry became much more focused on achieving decarbonization as a goal in and of itself, rather than on portfolio management as being the objective. I mean that's where we've seen a bit of a rebalancing effectively over the last 12, 18 months to say how do we think about the connection between our uh, decarbonization goals or our uh, sustainability goals and our investment goals? Where are their trade offs? Are we comfortable with those trade offs? If they are, how do we minimise them or mitigate them? Um, um, if those trade offs are in levels that we don't want to see. And that really comes down to the how question rather than the weather question.

Speaker A: Okay, so you mentioned mitigation as an overall focus for the way Schroeder zeros in on sustainability. Ah, seems like the hot topics recently, uh, in um, in this part of the industry are uh, focusing on adaptation and resilience as a part of longer term mitigation. How are they related to mitigation in terms of the investment priorities at Schroder's these days?

Speaker B: Um, well look, I think in many ways transition and adaptation are two sides of the same coin. Um, so when you have less of the first, it means you're going to have more need for the second over time. Um, we've got a slide that shows some of that picture. So what this chart looks at, it's using, looking over time at um, the long run, um, temperature that is implied first of all on the left by governments around the world and their policy ambitions. So what pledges have they set for decarbonization over the long term? The middle chart looks at the long run temperature rise that is implied by the policies that they've actually put in place, which are uh, predictably enough, a little bit less ambitious or stringent, um, than the ambitions or the pledges that they've made. And then on the right hand side, the long run temperature rise that's implied by uh, companies targets and the degree to which companies are intending to make changes. You can see, I think they've all got basically a roughly similar Picture, which is that while the first few years after the Paris agreement was signed back at the end of 2015, you had pretty speedy rate of improvement if you like, or more focus on transition, more focus on decarbonization. Whether that was in terms of the pledges countries are making, the policies they were setting, or indeed in terms of the sorts of targets the companies were laying at, it's basically flatlined for the last couple of years. If you look at the actual level of ambition on the left hand side, it's actually gone up slightly. Having hit um, around 2 degrees um, a couple of years ago. It's actually ticked up ever so slightly, but more or less we've basically stalled. And so as a consequence the importance of adaptation resilience and thinking about sort of the implications of climate physical, the physical effects of climate change become um, relatively more important, um, certainly over medium term. There is a caveat habit however, which is that because you've got about a decade or more lag between emissions being released and actually manifesting or creating physical changes in the atmosphere and in weather patterns and in uh, physical disruption, you can sort of say the future's already happened as in the next 10 years or so will be dictated by the emissions that have already been released and um, what the activity that we've already seen um, over the last 10 years and prior to that. And so in a sense when it comes to, is there any, is it a pendulum, is it a choice, is it, how much attention do we place on one or the other? Adaptation resilience have always been important because it is already significant. I said earlier that you're already seeing significant increases in the damage caused by the physical effects of climate change. And it doesn't really matter too much what happens over the next few years in terms of emissions reductions. There will still be, all else being equal, a uh, continued upward trend in the level of damage climate change causes. So there is a big focus, certainly we're putting more focus on it. I think one of the challenges that the industry has always grappled with in the past has been how do we actually go about analyzing this in terms of analysis and data availability. We started modeling this several years ago, um, and I won't bore everyone with the details, but really trying to assess essentially a sort of an insurance type model of the way or the sort of level of exposure or risks that individual companies face as data is improved, um, we're able to expand that and to extend that um, into other areas with a view of really trying to assess portfolios As a whole, because I say it's not a choice. You don't decide that you're going to be exposed to climate change, physical or transition risk. All portfolios are exposed. The only question is how exposed and how effectively are you managing that. Is it proactive or reactive? Um, where it gets a little bit harder. I think on the adaptation and resilience side of things is around the, if you like, the sort of thematic opportunities piece. McKinsey have got some numbers where they estimate that about 11% or so of total adaptation funding comes from the private sector. So pretty low. Um, and M, one of the challenges there is first of all around the difficulties of identifying those thematic companies, the fact that historically they haven't seen as much growth as perhaps some of the sexier areas of climate sustainability themes and the fact that a lot of our investment is in emerging economies or parts of the world where capital scarce, public support and institutional frameworks are often less developed and risks can be higher. But I think that is as you say, changing quite quickly and I think certainly we're focusing on it a great deal and I suspect it will be a much bigger focus for the industry.

Speaker A: Okay, so let's just talk a little bit uh now about um, nature based investing. It's obviously as you were saying, uh, just now, uh, there's some time uh, involved in from when carbon goes into the atmosphere and lots of other issues related to climate change and it starts to manifest in the real world uh, and have the impacts that it's having. Um, will investors integrate nature based investing with their climate efforts more going forward or does nature, nature based investing have a different path of its own?

Speaker B: Well, I think it's certainly got a, it certainly rhymes um, in terms of the path that's um, that's being approached. So if you look at a lot of the things that are being done across the investment industry or indeed the broader corporate industry around nature, they're following a similarly a uh, path that has been to a certain degree marked out and m defined by, by climate change over the last 10, 15 years or so. So whether that's around things like TNFD, which is more or less framed around the TCFD, which is the task force, the climate related financial disclosures. Mhm. There's definitely a commonality and if you say it really quickly, uh, nature positive and net zero sound like fairly similar things. But I think they are fundamentally require a somewhat different approach in a way. I mean you can think of climate change as both a subset of the effects of nature loss and also one of the drivers of nature loss. So they are intrinsically linked. Um, but it's also difficult to simply think about them as being, uh, the same thing as climate change or just wrap them up with the same question. One of the problems is that you've got lots of different areas that you're trying to bring under a single umbrella. So deforestation, water, ocean pollution, ah, species, uh, loss, all of these are, uh, different strands within that sort of biodiversity, um, field that the hope is that there's an ambition in places that we can come up with some unifying measure in the same way that carbon emissions are essentially a useful unifying measure when we think about the effects of, or the drivers of climate change. But it's probably going to be slightly elusive. I mean, we can see that there are a few measures that are being developed in different places, but the idea that we're going to come up with this one tangible thing in quite the same way is probably going to be, probably going to be difficult. So I think we have thought very hard about a very sensible. What's a sensible way of doing this? Um, our starting principle has always been to focus on what are we trying to measure, what are we trying to assess, and then to develop the best analysis we can with the data available to us, rather than thinking what data can we find and how do we turn it into a score. And I think this is one of the, this is quite a good example of the importance of really starting with logic rather than starting with data. And in this case, what we've done really at Schroders, and it's been a big focus for our organization over the last few years, is to state the problem as we want to understand the risks that companies will face through the effects that their business has on nature. And as we see more regulation in this area, as we see the, uh, physical effects of nature loss becoming more pronounced, particularly through value chains, that's going to become more and more important in the future. And we can debate the timing of, is that this year, next year, the year after that. But either way, structurally this is going to become a bigger deal for a lot of companies in a lot of industries. And so NatCapx, the model that we built, really brings together analysis of the exposure that companies have based on their business model and based on the sector they belong to, the way that companies are managing those exposures through their business practices and policies and through the benefits of their products and services that could help to avoid nature loss, to get it all into one sort of Unifying framework that allows us effectively to put a dollar value to companies or business models overall effect on nature. And that makes it slightly easier to then bring that analysis into the way we assess portfolios, the way we look at individual companies all the way for a growing increasing number of clients. Still a smaller number certainly than we see in climate change, but a number of clients around. How can we help build portfolios that help them to meet their objectives?

Speaker A: Great, Andy, it's been uh, a real pleasure to visit with you this morning and we want to thank you and everyone at Schroder's so much for all of your leadership in this area and the activity that you're showing through sustainable investment strategies, uh, and um, portfolio building for our clients all over the world. Uh, where online can followers of the Sustainable Finance podcast go to learn more about sustainable investment at Schroeder's and how can they contact you regarding the topics that we discussed in today's episode,

Speaker B: Let me just say as well, Paul, thank you very much for allowing me to run the Times. I expect for today's discussion. It's a topic, as you might imagine, that feels very passionate to me and thank you as well for everything that you've done, um, within the industry as well. Really important I think to be able to have uh, this sort of discussion. In terms of contacts, the Schroders.com website, um, has got lots of information that we publish, um, on this topic and many other topics. The other place I think is LinkedIn, where myself, my colleagues in the U.S. marina Sevanowski, um, and others are also very active and um, always very keen to connect.

Speaker A: Great. All right, well, thank you very much for your time today, Andy, and we look forward to putting this program up so that our followers can m get more in touch with how Schroders is focusing on sustainable investment today. My name is Paul Ellis. This is the Sustainable Finance Podcast.