NN IP: The art of responsible investing

NN IP: The art of responsible investing

ESG-investing ESG
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  • Effectively combining societal and financial returns key to successful responsible investing
  • With the broadening scope of ESG integration, responsible investors face tough choices but growing opportunities
  • The future will be all about increasing our impact to save the planet for future generations

Responsible investing is as much an art as it is a science. The decisions it entails are not black and white. As investors, we have a range of options at our disposal that can influence the lives of future generations and how we treat our planet and its resources. At NN Investment Partners, we are committed to helping investors find the approach that best suits their needs, while delivering financial returns and moving towards a more sustainable world. Jeroen Bos and Edith Siermann, who respectively head up responsible investing in equities and fixed income, discuss the choices facing investors and explore the trends in the rapidly growing world of sustainability.

Siermann and Bos share decades of experience in responsible investing and ESG integration and a deep understanding of the major hows and whys of combining financial and societal returns. They believe that responsible investing (RI) enhances risk-adjusted returns and contributes to global welfare. This is why NN IP systematically integrates environmental, social and governance (ESG) criteria into the majority of its assets under management – currently EUR 176 billion or 66% – and is constantly striving to increase this number.

“First and foremost, our aim is to improve investment results,” says Siermann. “And we believe that taking sustainability into account offers an improved risk/return perspective. In order to do this, we offer a broad spectrum of responsible investment strategies spanning a wide range of asset classes that suit diverse investor needs. For all our ESG-integrated products, the primary goal is and will remain to improve returns. For investors who want a stronger responsible tilt, our Sustainable products focus on today’s and tomorrow’s sustainability leaders, while our Impact strategies invest in companies that make a clear positive contribution to the UN Sustainable Development Goals.”

Becoming more responsible

Only 26% of fixed income investors in the market currently have a clear responsible investing approach while 49% intend to improve on this within the next three years, according to NN IP’s Responsible Investing survey[1], in contrast to 49% and 61% respectively for equities. Siermann is pleased to note that bond investors acknowledge the need to focus more on their RI approach, but believes we need to work on highlighting the importance of RI in fixed income as the opportunities here are enormous. Nor is she necessarily surprised that equity is further ahead than fixed income on RI integration. “One factor that makes it more difficult is that government bonds make up much of the fixed income universe, and ESG factors for countries are less developed than on the corporate side. To close this gap, we need better ESG data on countries, as this is often outdated or lagging. ESG rating agencies also tend to focus more on corporate ESG scores than country scores. This is changing but there is still work to be done.”

The survey also showed that 46% of investors are concerned about a lack of responsible investment opportunities. Bos acknowledges the need to inform investors about the options available to them. “As asset managers, we need to work harder to improve the visibility of our responsible investing approach and the broad and expanding range of responsible investing solutions. We also need to increase transparency on how we integrate and report on ESG criteria. The world of RI is changing rapidly and although the pace may differ between geographical regions and asset classes, the direction is clear. It has become mainstream and it is here to stay. This is underscored by the fact that we already fully integrate ESG criteria throughout the investment process for two thirds of our assets.”

ESG integration adds value

Siermann finds it strange that investors constantly ask themselves whether sustainability adds value. She turns the question around: “Sustainability has become a global theme and has great influence on companies and consumers. Why would taking ESG information into account not lead to better risk assessment and better performance?” Still, although ESG factors are important, they can’t determine future performance alone. “Their importance varies depending on sector and company and over time. We mustn’t lose sight of traditional financial factors. We incorporate ESG data into our analysis, but it’s important to maintain a holistic perspective when making investment decisions.”

Another major consideration in portfolio construction is whether to take a passive or active approach. Bos believes that to invest responsibly or make a positive impact, you have to make active choices. But the definition of active management varies depending on the investor. For some investors, active management means deviating from the benchmark, while for others it refers to the decisions made at the start of the process. “In our sustainable enhanced index range, we make active decisions, but we implement these choices in a passive-like way. This results in a portfolio that is similar to passive funds from a risk/return perspective, with a very low tracking error, while also having a strong sustainability profile. Meanwhile, our actively managed Sustainable and Impact ranges aim to outperform their benchmarks with the support of ESG integration and a focus on impact and the SDGs. So there is a range of possibilities from a responsible investing perspective when it comes to the level of sustainability, impact choices and risk/return characteristics.”

E, S, or G?

In our survey, investors deemed environmental factors most important for generating attractive returns: 66% of respondents selected environmental themes as return drivers, versus 40% and 15% for governmental and social themes, respectively. For Bos, however, everything starts with governance.

“Companies with governance issues might also fail to tackle environmental and social factors, which can have a significant business impact. BP and Volkswagen are good examples of E, S and G factors coming together[2]. Both companies have experienced notable environmental issues – the BP oil spill and the Volkswagen emissions scandal – but these are also intertwined with the S of employee safety at BP and the G of governance issues at Volkswagen. Negative social factors can also be very destructive for reputation and brand. For example, issues somewhere in the supply chain could be exposed by a single negative event that torpedoes a company’s reputation. The growth of social media has also significantly increased influence and reach, so a single event can have a much quicker and more severe impact than it did 20 years ago.”

With regard to the relatively lower attention paid to social factors, Siermann points to two specific causes. “One: there’s less data. Climate is leading the debate because we can measure a company’s emissions, making these factors much more concrete and tangible. Measuring social factors is much tougher and more qualitative – how do you measure employee well-being? Second: climate awareness is currently at an all-time high. But that doesn’t mean environmental factors are ultimately more important for performance.”

Other factors that can influence the degree of focus on specific E, S & G factors are geographic location, culture and market type. Integrating ESG factors into emerging market debt strategies, for example, often requires a different approach and focus from investing in developed markets, says Siermann. “In many emerging markets, governance is still key. For example, NN IP research reveals a link between governance and default levels in the Asian credit space. Different cultures also have a different approach to governance and what is seen as acceptable. In Japan, there is a lot less openness, which negatively impacts the efficient allocation of capital. Still, a rising tide lifts all boats. Even though some countries are more advanced, we are all heading in the same direction.”

Engagement versus exclusion

“Engaging with companies is how investors can make the biggest difference. As a shareholder, you’re essentially the boss of the management team and they will listen to you much more readily than to a non-shareholder,” according to Bos. “If you exclude, companies have less reason to respond, and you have less leverage to stimulate positive change. Of course, with certain companies, like tobacco firms, there’s little point in engaging as there’s no prospect of significant change. In that case, divesting may be the most effective option.”

“In the end, we are longer-term investors, says Bos “You should always look at the business’ prospects for the long run. Our ultimate goal is to earn a positive return for our clients, and research shows that when a company is improving in ESG terms, that also helps improve the stock’s risk/return profile.”

Investors need to look beyond companies’ current scores and focus more on ESG momentum. “If a firm has a bad score today, there’s no reason to immediately exclude it. Instead, you can engage with the goal of improving that score,” says Siermann. “If a company doesn’t score well but has strong momentum, that’s also a great investment opportunity. Companies with low scores can offer the most compelling opportunities, so they shouldn’t automatically be excluded.”

The huge and diverse alternative credit space is an area where engagement is paramount, Siermann points out. “Investors can have a strong impact here as the relationship with the company is often closer and the investment horizon is usually longer than that for listed stocks or bonds.” NN IP offers alternative credit solutions aimed at gaining exposure to UN SDGs and infrastructure in a range of markets. These investments can be tailored to the needs of investors and often have a direct effect on the real economy, making the results very tangible. Still, to accurately measure impact in the alternative credit space, effective data gathering and analysis is crucial. “This is especially true as the often unlisted companies have fewer reporting requirements, are generally smaller and often cannot measure everything themselves.”

Going Green

Siermann views green bonds as an especially compelling investment because of their direct link to concrete projects. “Investors can clearly see where their money is going and what their impact is. This link is less direct for more traditional corporate bonds. Right now, developed market companies and governments are the main issuers of green bonds, but I see significant scope for growth in emerging markets, particularly across Asia. China is already very active in green bonds, and other markets will follow. I expect demand to continue rising. For many investors, green bonds represent an excellent first step towards crafting a sustainable portfolio.”

“Investor fears about ‘greenwashing’ are somewhat justified, but there are more and more initiatives aiming to create an overarching taxonomy. Many of these focus primarily on the green bond itself instead of the issuing company,” says Siermann. “To make sure we are really investing sustainably, we not only review the green bond itself and what it is financing, but also the issuer. If both the bond and the company tick our boxes, then it’s investable for our green bond strategy.”

The future is impact

At NN IP, we measure the CO₂ emissions and water usage of our investments and analyse how these compare with the benchmark. But how we measure impact and its contribution to certain SDGs is far less developed. “It’s more of a qualitative assessment and rationale than it is proof of a quantitative contribution,” explains Siermann. “But there’s significant work being done globally on establishing better ways of measuring impact. And we will certainly be part of this discussion, even though we don’t yet have the answers.”

Measuring the impact of investments and finding the right data is a continuous challenge, admits Bos. “Simply taking an ESG score from an external provider is insufficient and can even lead to a portfolio that actively does harm. Translating material factors into numbers isn’t easy. But if something is important, we should make every effort to quantify it.”

Measuring exposure also provides a path forward. “When it comes to the SDGs, you can say, ‘XX% of our portfolio is supporting the energy transition.’ And you can clearly see that these companies are having a positive impact in that area. In the cases of gender diversity and R&D spending, for example, we look at a company’s performance relative to the benchmark. For our impact equity portfolio, the ability to demonstrate a material positive impact is a crucial factor in our investment decisions. This means we look for companies that are innovative solution providers with solid business plans.”

Technological innovation could be the key to better interpreting and using ESG data, expects Bos. “The quality of ESG insights clearly has room to improve further. Partly through better data and increased corporate transparency, but also by using alternative data sources, and new technologies such as natural language processing and machine learning.” NN IP increasingly incorporates new technology and alternative data sources, enabling us to generate more timely signals and gain a fuller understanding of ESG factors.

Ultimately, creating a more sustainable society for our children will mean using all the resources at our disposal to analyse impact and spur on stronger ESG integration. This is reflected in NN IP’s commitment to expanding and enhancing its product offering to fulfil the needs of an increasingly broad range of responsible investors. Both Siermann and Bos believe that effectively measuring impact could be the next frontier in responsible investing, especially as RI evolves further and expands into an increasing number of asset classes and investment vehicles. “Twenty years ago, it was all about exclusion. In the last ten years, it has been about ESG integration. The next ten years will be about how to measure and increase our impact. This is something that forms one of pillars of our responsible investing approach as the better you can measure an impact, the better you can make one.”

[1] Source: NN Investment Partners’ Investor Sentiment: Responsible Investing survey, May 2019. 290 professional investor respondents. Respondents were drawn from five main areas: France, Germany, the Netherlands, Italy and Belgium, with a further panel of respondents collected from the UK and Scandinavia.

[2] For illustration purposes only. Company name, explanation and arguments are given as an example and do not represent any recommendation to buy, hold or sell the stock.