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E2W member Elena Vydrine - “What is responsible investing?”

E2W member Elena Vydrine - “What is responsible investing?”

Katie.Dix / 19 Jun 2019

Invesco are kindly hosting an E2W event in September around the theme of Resposible Investing. Elena Vydrine, a member of E2W, will be publishing a series of blogs in the run up to the event on the topic of ESG. If you would like to sign up to attend this event, please register your details here

Elena Vydrine is a Head of Portfolio Management and ESG Integration at Ryedale, a company developing portfolio management software with integrated ESG factors. Over the last 12 years, Elena has worked in the asset management industry specialising in passive equity funds that track financial indices and alternative indexation like smart beta and ESG. Previously involved in Responsible Finance project in the capacity of Research Associate at HSBC Asset Management.

Responsible investing, diversity and what’s in it for you.

The practice of sustainable finance and sustainable investment strategies are far from new. Going back to 1960s, emergence of socially responsible funds (SRI) reflected the ethical convictions of the investees by offering strategies that would exclude certain type of companies or industries from the portfolios, typically gambling, tobacco, weapon or other ‘sin’ companies, which were incompatible with moral and ethical values of the investee.

Since then responsible investment strategies have evolved to a much more holistic understanding that companies operate in physical and social reality and have imprint on the reality they operate in. This has been coined as ESG investing, i.e. investing with the mind of Environmental, Social and Governance factors alongside the traditional financial company analysis. The ESG thesis is grounded on the belief that value creation is influenced by more than financial capital alone, particularly if long-term horizon is considered. It is also being argued that companies with stronger corporate social responsibility practices experience less controversies and are more ‘future-proof’, which ultimately leads to superior financial performance.

Although efficacy of the ESG data factors is still debated by the traditional investors who do not incorporate economic externalities and intangibles into their valuation models, solid academic evidence emerges on the materiality of the sustainability issues for corporate financial performance. BP Deep Water Horizon oil spill, Volkswagen diesel scandal, bankruptcy of Weinstein Company following sexual harassment and abuse court case, Facebook and Cambridge Analytica data privacy scandal, are recent infamous examples of companies going through a turmoil and how investor’s portfolio can be affected by those ESG-related events.

Indeed, investors are taking this knowledge on board. Global assets under management linked to companies that are signatories to the UN PRI (United Nations Principles for Responsible Investment) which actively promote ESG integration into mainstream investment processes, have grown exponentially to $86trn over the last thirteen years since its launch. This is driven by the increased expectations from the asset owners who recognize the risks and opportunities in this new holistic investment evaluation framework, as well as evolving shifts in cross-border regulatory and legislative landscape where ESG principles are being increasingly incorporated into fiduciary duty concept through stewardship, corporate governance codes and standards as well as mandatory sustainability disclosures. In fact, it is increasingly demanded by the large asset owners, like pension funds, that ESG factors are integrated into the full cycle of investment process for all the funds, rather than serve as peripheral factors for the niche strategies.

Moreover, the demand for sustainable investment products is expected to grow further as we are faced with sustainability challenges and emergencies like climate change, demographic explosion, rise of income inequality, antibiotic resistance, plastic pollution and water scarcity to name but a few. Digital revolution and ‘big data’ are also fueling and accelerating the sustainable investment revolution. The emergence of the systemic morbid threats to our planet and humans poses a question to economists and the financial sector in particular.  Does current economic model accurately reflects the social and physical reality in which businesses operate?

Investors expect a more holistic understanding of firms’ value creation as well as the ability of their funds to finance change to a more sustainable future. It comes at a time when there is a clear realization that the financial results that are being used in the traditional valuation models, only expose the tip of the iceberg in terms of the long-term value of the company. It is therefore reasonable to expect that rational investors incorporate ESG issues not just out of niceness, but because they care about the resilient and forward-looking business models as well as the socio-economic environment beyond the mere next set of quarterly results.

While the environmental factor is often seen as the most pressing one out of the ‘E’, ‘S’ and ‘G’ pillars, driven by the climate change and an urgent need to address it, below are some of my reflections on a less discussed factor, ‘S’ – the social factor.

Human capital, as part of the Social pillar of the ESG framework is defined as the next generation of responsible investment integration in investment analysis. More specifically, respected academics argue that intangibles in the form of employer relations are not fully incorporated into the company valuation and that there is a positive relationship between satisfaction and the stock price of the company.

Gender diversity, as one of those ‘S’ factors, has also been reported to have a correlation with earnings performance, where companies with strong female leadership generated higher Returns on Equity than those without. Furthermore, companies that lack board diversity tend to suffer more governance related controversies than average. 

Gender Pay Ratio disclosure in the UK (Equality Act 2010) revealed the potential risks and materiality of pay disparities. In February 2018, the law firm Leigh Day has launched £4bn equal pay claim against TESCO, the largest ever equal pay challenge in UK history on the basis of equal worth claims, where employees working in the male dominated distribution centers are paid considerably more than the largely female staffed Tesco stores.

On the other side, the latest 2019 report published by New Financials in collaboration with Pension and Lifetime Savings Association found that asset owners’ motivations for tackling issues of workforce diversity were beyond that of ethical equity. Asset owners are acting on improving gender diversity because it has shown to improve decision-making, attract and retain talent, allow better innovation and completion strategies, reflect members and communities and ultimately, allows to enhance financial performance. New Financial said these reasons were “not mutually exclusive; rather they overlap and reinforce each other”.

Furthermore, this report on Investors Perspectives on Board Diversity showcases just how proactive the approach to increase and maintain board diversity is amongst pensions funds, institutional shareholders and proxy advisory firms. “Simply put, board diversity is good for business. It is essential in today’s global economy that boards avoid ‘group think’ and ensure there is the breadth of experience, skills, and knowledge necessary to meet complex business needs.”(Anne Simpson, Investment Director, Sustainability, CalPERS)

However, this is not all. Women leadership is increasingly linked to sustainability advocacy potential.  Why women are considered to be the secret sauce for better business growth linked to the Global Sustainability Goals? The analysis by the Business Commission, Better Leadership, Better World shows gender-balanced leadership is not just ‘nice to have’. It is imperative due to the skills women bring that are critical for any successful business strategy and are also aligned with the sustainability agenda: long-term thinking, innovation, collaboration, transparency, environmental management, and social inclusiveness. This is in line with the theory of cognitive diversity, which includes people who have different ways of thinking, different viewpoints and different skill sets in a team, particularly relevant and valuable in the shifting and dynamically changing business environment and market place.  Women leaders are accelerators that can help unleash a massive economic prize – more than US$12 trillion per year –  for companies that align their strategies with the Sustainable Development Goals (SDGs): 17 objectives to end poverty and hunger, reduce inequalities and tackle environmental challenges by 2030.

It is also interesting, that while women are often seen as recipients of aid and in need of empowerment when talking about equality, they are, in fact, a cornerstone of growth and business empowerment. Businesses are beginning to realise this through collaborative initiatives like E2W,  30% club and Woman on Boards in order improve gender representation at the executive level.

What about you? Do you know your value and potential to challenge the old way of things in order to build a more prosperous and peaceful future? Watch these inspiring leaders sharing their stories during International Conference on Sustainable Development during the discussion on the ways women are leading the world to meet the SDGs and what is needed to bring more women to the forefront of delivering their ambitious agenda.  This conversation is spearheaded by sustainability champion, Gail Klintworth, and the analysis by the Business Commission analysis - Behind Every Global Goal: Women Leading the World to 2030.

Diversity and effective women leadership has a big part to play in changing the status quo and mobilising the financial sector to support transition to low carbon economy as well as tackle socio-economic challenges of income inequality, poverty and lack of social mobility. Indeed, campaigns like Fearless Girl, mutual funds gender diversity scoring platform Gender Equality Funds,  MSCI Women Leadership indices and emergence of the  investment funds like Impact Shares YWCA Women’s Empowerment ETFSPDR Gender Diversity Index ETF (SHE), prove investors are getting diversity on board of their investment process and it is not just a fad. This is important, as investors may now invest in companies with higher levels of woman leadership and commitment to diversity among their board of directors and executive positions. Companies themselves may now feel on the spot since this data is being collected and analysed by the investment community.

In fact, it would be sensible to do your own ‘ESG analysis’ on the company you are considering as your potential employer. Not only it is going to be more productive environment in terms of ethics and motivation to work for someone who cares about its people and considers the consequences of its business operation on the environment and the society, it is also much more likely to be a setting with better support in terms of training and development, career progression, access to better insurance, health care and pension provisions, flexible working arrangements, working for a more dynamic team and a ‘future fit’ strategy and last but not the least, have a fair remuneration.

To conclude, it is clear that there is a commercial advantage for asset managers to improve risk management and business resilience as well as to gain their competitive edge through innovative solutions using ESG criteria. Practices that incorporate these extra-financial factors are set to place greater emphasis on sustainable growth beyond the traditional short-term earnings approach. This, in turn, will allow to establish the basis for more sustainable value creation as well as adding social benefit within the communities in which those businesses operate. By looking at the challenges of income inequality, climate change, demographic growth from the lens of investment risks and opportunities, it is evident that inclusive growth benefiting all members of society is vital beyond ethical considerations. Systemic issues of social cohesion, financial stability and economic growth mean investors interests are deeply intertwined with the long-term sustainable outcomes for the economy and wider society.

If you found this interesting and would like to find out more about whether the financial industry can do well by doing good, please register here for your space at our upcoming event. 

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