Cambridge Associate's sustainability lead offers thoughts on how ESG investment should be put into use, how it can be measured and what some of the pain points in this area continue to be.
Chris Varco is based in London and is managing director of sustainable investing at Cambridge Associates. The Boston, Massachusetts-based asset manager has traction in the sustainability space and applies ESG criteria across all its investment platform. This publication spoke to Varco about the due diligence that goes into integrating ESG components and measuring their impact, and what elements of the "50 shades of green out there" are being driven by private clients and basic economics. His advice is "drop the idea of the starting point being what is this going to cost me?" (This item is part of a series of articles examining ESG. To see the editorial analysis of the subject, see here.)
Covering this topic for wealth managers it has reached a diluvian moment, where we are inundated with ESG proclamations, and knowing what is genuine and what is less so is difficult. So can you explain your role on the research and implementation side of ESG investing?
I head up all of our work in London on thinking about ESG and building private clients portfolios, where that is a key lens, then doing due diligence on managers where there is a very heavy ESG component. So it is a dual role between finding the investments and then building client portfolios.
How do you set an ESG portfolio? How do you assess the companies, the managers, and reach certain decisions?
It is a good question. I think your point about there being an explosion of products is entirely true. There was a Times supplement last week about ESG investing. There are definitely 50 shades of green out there. The starting point was originally the ethical beliefs of investors, which stems right back to the 1980s, whether it is avoiding apartheid in South Africa or tobacco. So if it is avoiding those in your portfolio, then there is a sideline in "let’s actively create good outputs", which would be impact investing.
When do you think the switch began from just screening out to investors being more proactive?
It is gradual, and we work on both. Certainly with private clients that proactive aspect is what is gaining traction. I think the switch is just driven by an economic basis. We are not about labelling ethical funds. We are genuinely not using the “ethical version” of a UK equity fund that is a negatively screened version of something else.
How do you differentiate?
We are really trying to find those managers who are proactively looking at massive sustainability issues like climate change, transferring to a low carbon economy, what we call a multi-stakeholder society, where externalities get internalised really quickly, so that you can’t behave in an unsustainable way without it being on Twitter and the greater accountability attached to digital and the massive issues being raised around resource scarcity.
There is a growing economic basis behind this and a growing economic basis behind the solutions. It is amazing in a decade how we have gone from the situation where wind and solar were multiple times more expensive than gas or coal-fired electricity. And now they are falling below them in cost.
We have funds seen through the ESG lens that have been number one in our database since their inception for emerging markets, and global equities, so we can move beyond the idea that this is a discussion about ethics and tradeoffs and think about a choice that makes economic sense.
From your assets under management what share are in impact investing?
That is a difficult question. We have about 200 clients who are very proactively pursuing those strategies, and all at different levels between that. There are investments doing this as a main strategy, in depth, but the key for us as a firm is that we are now collecting ESG data on every single fund we do due diligence on. That is the big real change over the last five years. We are asking those questions to hedge funds, to private equity and to venture. The move to this focus is just becoming ubiquitous. That doesn’t necessarily mean labelling.
What do performance benchmarks mean to investors? As it is not standardised yet, how do you judge what is credible?
Yes they are really confusing because there are basic ones that exclude a few things – arms, tobacco – then there are the more funky ones that actually tilt the weight more towards positive companies, and there are the low carbon ones …
Which indices do you favour in terms of ESG becoming more standardised?
We have done lots of work with clients on climate aware indices. You can reduce things like carbon emissions and exposure to fossil fuel companies and things that may well be at risk over the next 20 years, for obvious reasons, with minimal tracking error. That is an example. We have worked with managers to create a very interesting new global equity low-carbon indices.
Is climate where there is most appetite? How do you narrow it down in terms of investor alignment?
Climate is a big one. But lots of private clients and families are looking at investing in social impact as well and investing back in their own communities. With climate there are lots of ways to invest in solutions. You can be investing in renewable infrastructure, but we also look at education and healthcare strategies. There is a whole mix and climate is a big deal but increasingly a lot of European investors are looking at the United Nations Sustainable Development Goals (SDGs) and there are lots of managers trying to align around that social and environmental framework.
But it is incredibly broad.
It is very broad. I think goal eight is economic growth, which is incredibly broad, and some managers shoehorn any company into that category on the basis that it is growing. Again, you need to be very wary of green washing.
When you look at asset allocation, what do you ask managers to report on that show these global issues are being tackled?
We assess the manager’s investment strategy on two levels. We look at the firm level, so what policies they have in terms of ESG considerations. And how they are thinking about climate risk, and importantly, how they are thinking about stewardship. So how are they voting with their shares and thinking about environmental, social and governance issues, and how are they engaging with underlying portfolio companies on areas like gender, climate risk, all manner of things. Are they an active owner? Policy can only get you so far. You can have a policy on absolutely everything but the question is what are people actually buying?