10. The Tipping Point Has Happened
A constant refrain within the sustainable investing community is whether we’ve reached the “tipping point” for ESG and impact investing. Admittedly, it’s hard to know exactly how a tipping point is measured, but we boldly posit that we’re past it. One can look at the widespread adoption of ESG principles, the booming green bond market, flows into ESG and impact investing products, progress on impact measurement and management, and how the SDGs and impact investing have seeped firmly into the culture as evidence of the ‘mainstreaming’ of sustainable investing. This movement is not only driven by those in the investment community, but also by consumers with the choices they make, local communities with how they define their investment priorities, and by companies with their commitment to sustainability i.e., all stakeholders are mobilized.
Arguably, however, the biggest driver of the changes we’ve experienced over the past decade is the availability of data. At KKS, we now see investors moving past simply consuming ESG data at its face value, and now onto considering the interplay between ESG data and other data sets (e.g., econometric, political risk, social media). Our quant team has spent significant time evaluating the strengths and inconsistencies of ESG data, and we are now helping companies take control of the data and customize it for their needs. Investors, in particular, have been seeking to optimize ESG factors in portfolio construction, with the goal of achieving better, risk-adjusted returns. All evidence of a maturing and innovating market – one that’s certainly past the tipping point.
9. An Alignment to the SDGs (or, Connecting the Dots)
The United Nations’ Sustainable Development Goals (SDGs) were adopted by all United Nations Member States back in 2015. The sustainable investing community has been discussing linking investment outcomes to the seventeen SDGs since then – and in fact, there are many investment vehicles set-up to explicitly make and report on progress towards the goals. Coinciding with the general movement of raised expectations for the private sector, this year we’ve been hearing from both asset owners and asset managers seeking to link their investments in ESG factors to a company’s progress toward the SDGs. We believe a good solution is to map what’s material for a company, using the SASB materiality framework, to the SDGs (as laid out in this paper), thus creating a link between financial materiality and progress towards the SDGs. The prerequisite to all of this is, of course, an ESG integration strategy and a robust reporting framework . . .
8. Climate Risk Assessments
If you’re reading this, you’re likely well aware of the impacts of climate change and have taken steps in your life to reduce your carbon footprint. However, there continues to be a need for additional policy changes and solutions in order to drive systemic change. To help address this, there are organizations seeking to raise awareness about lesser known effects of climate change. For example, the Medical Society Consortium on Climate and Health, which is an organization of medical professionals that is working to spread awareness about the medical impacts of climate change. They say we can expect everything from increasing incidents of heat exhaustion to higher cases of mosquito or tick-borne diseases. This impacts everything from medical training to medication supply and staffing decisions at hospitals.
At the same time, we’re seeing more demand for climate risk assessments from various types of investors. They want to measure and ultimately reduce their exposure to climate change-related risks. But how does one make sure their risk assessments consider all potential impacts? The method we employ is a systems-level perspective to assess climate change’s far-reaching impacts on society. And unfortunately, we expect increasingly more disruptions in the years to come.
7. Smaller is Better
Let’s face it, the sustainable investing conference circuit has become big business. Ticket prices are often well north of $1000 and attendance is counted in the hundreds, if not thousands. We have been hearing from clients and friends of KKS that they’ve decided to skip the big conferences in favor of smaller, intimate gatherings that focus solely on sustainability issues pertinent to their work. That’s good news for us because we’ve helped plan several convenings where small groups gather to advance the discussion from critical ESG and impact investing challenges to solutions. Other benefits: networking is manageable, these convenings are typically free, and they don’t take up your whole day let alone half your week. Also, good chance there’s better food and coffee. Sign us up.
6. All-Encompassing Impact i.e., The Future of Fill-in-the-Blank
For many investors, impact investing represents an opportunity to align values to investments to produce positive impact. Over the past decade, many impact investing products have been focused on one or a few sectors or themes (e.g., microfinance, aquaculture, or green energy). We’ve recently noticed a shift to a broader or more macro view of impact, with funds emerging around central themes that are more focused on mega trends or reacting to the impacts of a world in flux. These funds might have a central thesis around ‘the future of work’ or ‘the future of cities,’ and they consider macro themes such as climate change and globalization, measure the shifts resulting from technological and demographic forces, and weigh geopolitical changes as part of their investment decision making. As a result, these funds seek to produce positive impact across various sectors and are defining impact investing at a systems-change level. Of course, impact measurement and management becomes more complex, but the IFC Operating Principles for Impact Management is driving a common discipline around an end-to-end process for the management of investments for impact. We’ve seen an uptick in clients seeking to implement the Principles and subsequently attract impact-aligned capital.
5. Corporate Social Impact
Companies have long self-touted their corporate social responsibility (CSR) efforts to demonstrate how their businesses are operating in ways that benefit society and the environment. CSR takes on many different forms and varies by organization. Some companies will largely avoid assessing their business operations but will discuss their philanthropic and community engagement efforts. On the other hand, companies with more deliberate social impact efforts may focus on how their products have entered new markets or satisfied unmet needs, how they’ve improved working conditions or employee programs, or how they’ve implemented sustainability measures in their supply chains.
Through our client engagements defining material ESG factors and measuring and reporting on progress, it’s clear that a shift is underway with corporates thinking more holistically about their impact. Social impact is being integrated into decision-making across management layers and executive compensation is being tied to sustainability improvements. Corporates are also seeking to better understand best practices when it comes to board governance and sustainability performance (see this whitepaper we created with Ceres for more information). And we’re even seeing corporates seed proprietary social impact funds to explicitly target producing positive impact - Salesforce Ventures is perhaps the most prominent example of this. Could we be witnessing the evolution from CSR to Corporate Social Impact (CSI) as a strategy to create value? One indication is the issuance of an annual CSI report instead of a CSR one. Keep an eye out for more of these in the future.
4. ESG: What’s in It for Me?
With companies being evaluated through ESG lenses and more investors engaging with them asking for ESG disclosures, companies naturally ask “what’s in it for me”? We see this as a positive development towards the completion of an ‘ESG circle’, with a symbiotic relationship developing between asset owners, asset managers, analysts and corporate actors. For example, in October 2017, the Massachusetts Bay Transportation Authority (MBTA) issued the first tax-exempt sustainability bonds in the US, successfully testing the thesis that impact-focused bonds may result in lower borrowing costs (read more in this case study from UNPRI). And over the past two years, an ESG- or sustainability-linked loan (SLL) market that ties a borrower’s interest rate to improvements in ESG targets has also developed. The first loan of this type was led by ING and issued to Philips in 2017 for $1.2bn; in 2018, there was over $36bn of global SLL issuance.
With the value creation and risk mitigation elements of ESG now more understood and the lower cost of capital thesis being proven in the market, we are seeing more corporates in our advisory practice seeking to better understand their ESG score and then implementing practice improvement plans to deliberately target improving the score. If you’re curious to learn more about how ESG integration can bring more value to your organization, send us a note at: email@example.com.
3. More Effective Engagement
ESG and engagement go hand-in-hand. And why not? If you’re an asset manager that engages with a corporate on a material ESG issue, your goal is for them to focus and make progress on that issue so you can capture value. Added benefit: you prove your worth as an active manager. Sounds simple and straightforward, but it’s far from that. Engagement or stewardship teams spend a great deal of time defining, executing and managing their priorities. They interact with people in various types of roles on the other end, some not too keen to have even more work given to them. With limited resources, not all asset managers actively engage corporates or focus on stewardship as a priority.
At KKS Advisors, we’ve researched engagement practices and reported on different management responses and outcomes. We’ve found that there are best practices and more effective ways to engage (see this article in Barron’s by Mindy Lubber of Ceres and KKS co-founder GeorgeSerafeim for more). There are also ineffective engagement techniques (we recently heard from a pension fund that 25% of their engagement activities fail). By studying engagement practices, we can determine how they can be made more efficient, how resources can be better allocated and recommend more effective ways to track engagement activities. With this knowledge, could more asset owners and asset managers commit resources to ESG engagement? We’ll have to wait and see.
2. The Velocity of ESG in Private Equity
With their longer-term investment horizons and stewardship-based ownership structures, private equity (PE) firms might just be the ‘sweet spot’ for ESG. Some of the largest players in the industry (KKR, TPG, Partners Group) clearly understand this and, with their significant resources, have built dedicated ESG teams. But there are a lot of PE firms out there that are also committing to ESG – either dipping their toes in the water via a tactical ESG due diligence on an upcoming acquisition or jumping fully in by planning and executing on a complete ESG integration strategy. So far in 2019, our advisory practice has seen the biggest year-over-year change on inbound inquiries coming from PE firms. As one GP recently put it, they are going to be exiting the investments in their next fund in 7-10 years when “the world will care a lot more about sustainability than it does today.” We can only hope.
1. Corporations are People
Back in 2011 when our political controversies were a bit more pedestrian, presidential candidate Mitt Romney told a crowd of hecklers at the Iowa State Fair that “corporations are people”. For some, this statement reinforced the notion that Romney was an out-of-touch businessman as the founder of Bain Capital, a very successful private equity firm in Boston. Fast forward 8 years and Bain Capital now encompasses Bain Capital Double Impact, an impact investing fund (led by Deval Patrick, ironically a former politician and governor of Massachusetts), and the role of corporations in society is widely being re-considered. In this recent HBR podcast, Bob Eccles discussed how corporations were originally formed with a limited lifespan and now, for the most part, have eternal life. Shouldn’t they then be accountable to more than just their shareholders? Can we find harmony between people, planet, and profit? Perhaps we should treat corporations as “people” in the sense of rewarding those that create value by positively contributing to it, while punishing those that are a net negative to society. An orientation away from short-termism to a long-term strategy would be a good place for corporations to start.