“There are a lot of funds out there that have some ESG label or indicator on it, but the asset manager will have a hard time showing “what’s ESG” about the fund”.

Praveen Gupta: What constitutes a genuine Environmental, Social & Governance (ESG) fund and why is it not so easy to identify one?

Harald Walkate: People don’t agree on what they expect from ESG funds, so it’s also unlikely we will end up agreeing on the definition of a ‘genuine ESG fund’. To me, an ESG fund is genuine when the investment team has some sort of investment conviction that is related to ESG, and they can clearly articulate this conviction, but also explain what that means for the investment process and for expected outcomes. I call this the “Conviction & Narrative” approach. But other people believe, for example, that oil is “not ESG”, so any fund that invests in oil companies can not be genuine, even if the point of the investment team is to work with that oil company to reduce emissions or develop renewable technologies. Genuineness is in the eye of the beholder.

PG: What are the key ESG considerations that ought to be incorporated in an investment strategy? How easy or difficult is this process?

HW: I think investors should focus on ESG considerations that are ‘material’; i.e. considerations that influence your investment decision: you would make the investment decision differently if you did not have access to this information. But that means that it depends what kind of investing you’re doing and which sector or businesses you’re investing in, which ESG considerations you look at. One of the things we’ve learned after about 15 years of doing ESG integration is that materiality is ‘situational’. And I think people are making this out to be much more difficult than it actually is; in my experience in working with portfolio managers and analysts it is relatively straightforward to work out which issues are material.

PG: How crucial is the role of an ESG team and what should ideally be the most critical skillsets?

HW: Here also, it depends. I’ve worked with asset management firms who have no ESG team, or a very small one, and who are better at understanding ESG issues than many asset managers with very large teams. I think the critical skillset is: (1) have true expertise in certain ESG issues, recognizing that today almost everyone calls themselves an “ESG expert”. ESG is also very broad so you can’t be an expert in all of these things. (2) understand financial markets and investments. ESG is a wonderful thing but you have to recognize that you work in an investment organization. If you don’t know what that entails, or understand who you’re investing for and what preferences and restrictions that comes with, you will not be very effective. (3) be a teamplayer. You need to be able to work with investment, research, compliance, legal, communications people, and perhaps also with other experts in other organizations. If you’re not a self-starter or reach out to people easily then you’ll likely not have much impact.

I’ve argued that we should take a much more qualitative approach to attribution. Also, when talking about impact investment, we have to recognize that most outcomes cannot be attributed directly to any one specific company, project, or investor.

PG: What is attribution assessment? How important is it?

HW: It is assessing, or measuring, what the outcomes are of your ESG approach. It is quite important, because you want to know if your approach is working, if your theory of change is correct. At the same time, attribution is usually very hard to measure precisely – i.e. quantitatively – and I’ve argued that we should take a much more qualitative approach to attribution. Also, when talking about impact investment, we have to recognize that most outcomes cannot be attributed directly to any one specific company, project, or investor.

PG: Regulatory guidance could vary from a regulator to regulator.  Do you see emergence of a common standard?

HW: Not really. Roughly speaking you see regulators who expect a lot from disclosure, with the idea that once we have transparency on ESG things that companies and investors will do something about them –  something I’m rather skeptical about. And then there are regulators who try to directly change, incentivize or ban specific activities, which makes more sense to me. There does appear to be a common standard emerging in how regulators are looking at ESG funds, in many countries (eg. UK, Switzerland, Denmark, US) guidance has been issued that – boiled down to the bare essence – tells investors to “say what you do, and do what you say”. This is very similar to my Conviction & Narrative approach.

PG: What is the significance of a fund label? Can it trigger greenwashing? Constituents of ESG fund sometime look no different from any other fund?

HW: The significance of labels is extremely limited. There are many labels out there, with different standards, which is confusing to the customer. Also most labels are pretty easy to get, as long as you pay. And then there are new ‘labels’ in the form of Sustainable Finance Disclosure Regulation (SFDR) classifications article 8 and 9 – those are actually free (even though you have to disclose a lot of information on those funds but that’s doable for most large asset management firms) and the requirements for when you can opt for art. 8 or 9 are relatively light. In other words, yes, there are a lot of funds out there that have some ESG label or indicator on it, but the asset manager will have a hard time showing “what’s ESG” about the fund, and indeed many of these funds will be basically undistinguishable from conventional funds.

PG: Would there be some businesses (Oil & Gas in particular) that you would not expect to see at all?

HW: No, not really. As said above, ESG means different things to different people. Some look to ESG funds for values-alignment, others for outperformance, and yet others for ‘impact’. So it depends what you want to achieve to say what should and should not be in your fund. The main challenge for us should be to educate consumers about what you can and cannot achieve to address ESG issues through investments, not so much trying to have objective rules on what should or should not be considered “green’”  or “sustainable”.

Presumably the investment industry would consider it ‘allowed’ to have ESG funds that invest in gas & nuclear. But at the same time…there would be asset managers who see a market opportunity for funds without gas and nuclear, and would call them “true sustainable” funds…

PG: Wells Fargo, Citi, Morgan Stanley received a boost in their green credentials from MSCI Inc. even after providing $74 billion to polluting companies?

HW: I’m not familiar with these cases but usually whether or not large banks provide funding to polluting companies makes extremely little difference to the problem of pollution or climate change. Instead of wasting time pointing fingers at polluting companies or their banks, people could be much more effective by trying to change the bigger system, e.g. engaging in the political process, calling for the needed taxes or subsidies, or working out ways to stimulate the development of new technologies.

PG: If Nuclear energy and Gas were to be classified as green in the European taxonomy, how would ESG funds treat them?

HW: Presumably the investment industry would consider it ‘allowed’ to have ESG funds that invest in gas & nuclear. But at the same time, presumably there would be asset managers who see a market opportunity for funds without gas and nuclear, and would call them “true sustainable” funds, or whatever. All of this is not going to make much difference at all to the problem of climate change – what’s decisive is how the EU and other governments will use industrial policy, taxes and subsidies to transform our economy and how much they will rely on nuclear and gas in these activities. Right now it doesn’t look like the Taxonomy is going to play a very big role in that decision-making.

PG: Many thanks Harald for demystifying some of the concepts relating to ESG. Looks like I still need to better my understanding as to how ESG investing can direct the money pipeline towards addressing the Climate Emergency.