What is sustainable investing?

Roy Thompson speaks with Phoebe Stone, Head of Sustainable Investing at LGT Vestra. Sustainable (or ethical) investing has become increasingly popular, especially in recent times, as people look to leave the world in a better place for future generations. In this episode, Phoebe explains what sustainable investing is and the effect it can have on financial returns.

They discuss:

• The incorporation of non-financial factors in investing (Environmental, Social and Governance)
• Academic research that has shown that sustainable investing can produce stronger financial returns for the investor
• The effects of Covid-19 on sustainability decisions
• How investment markets can influence corporate governance
• The future of impact investing

Transcript

Roy Thompson : 0:00

Hello and welcome to the Retirement Gym. This is the podcast series that aims to help you make good retirement decisions in the lead up to retirement and how to spend your money through retirement. My name is Roy Thompson, I head up MHA Carpenter Box Financial Advisors. We're a firm of independent financial advisors who do a lot of work around the notion of retirement planning. Today I've got with me Phoebe Stone. Phoebe is Head of Sustainable Investing at LGT Vestra. She joined there as an Investment Manager in 2014, through a natural interest and charity work she took the chair to head up their Sustainable range in November 2018. Sustainable investing perhaps used to be called ethical investing, now more commonly known as environmental, social, governance, or ESG, for short, has become more and more popular in recent years and that's accelerated, I would say, through the likes of the Coronavirus. I guess when we think about retirement, we're trying to consider how we can make our own finances last through our retirement, it would seem sensible that there is a link to how we can ensure that we leave the world in a better place than perhaps where it is just at the moment. So there seemed a natural link to ESG investing. And Phoebe's got very good experience in that area. So hello, Phoebe, thanks for joining us. Thanks for coming along today.

Phoebe Stone : 1:28

Hi, nice to see you. Yeah.

Roy Thompson : 1:30

So, the topic of conversation, I guess, is around sustainable investing. That the modern acronym that's given to that is ESG, which stands for environment, social and governance. That sounds like quite a quite a mouthful. I guess for listeners, they would be more used to ethical investing, which was historically what it was know as. Do you want to tell us a little bit about what's evolved over the course of the last few years in in this sort of sector of investment and why that's evolved?

Unknown Speaker : 2:05

Yeah, absolutely. Thank you. So I think lots of people are familiar with ethical investing. Ethical investing can be traced all the way back to the Quakers, whereby they wanted to exclude some activities or sectors from the companies that they invested in. And that's really what ethical investing is, you're taking an investment universe, and you're reducing it based on a set of values or belief systems. It's also referred to as SRI investing or Socially Responsible Investing, and also Exclusionary Investing. All of these phrases really mean the same thing, whereby you're reducing your investment universe. You can go down a very exclusionary route by which you're left with a very small investment universe. But things have moved on quite considerably since that quite rudimentary style of of investing and ESG investing are as you say environmental, social and governance investing has become extremely popular. What this type of investing is, is the incorporation of these environmental, social and governance factors within an investment decision. If we think of traditional investing, all an investor would really think about is financial factors of a company. So it could be revenue projections or profit margins. And those are often explained to investors using various ratios. So, price earnings, you might have heard of, price to book, return equity. What ESG investors look to do is yes of course incorporate those financial metrics within their understanding of a company, but they also look at these non financial metrics. So for example, the environmental factors may be how much water is used in the production process of the company. The carbon emissions, the carbon footprint, how much renewable energy is used, where the company sources raw materials from, are they responsibly sourced, for example. Under the social banner, you've got things like the health and safety policy of the company, the health and safety record, whether the company offers flexible working, how diverse the workforce is, what the employee satisfaction levels are and of course consumer satisfaction, as well as things like supply chains. Finally, from a governance perspective, independence of the board is a really important one. Renumeration policy of that board, bribery and corruption. And you can start to see these are incorporating lots of other factors into your understanding of how that company operates and it provides more of a holistic picture really, in your understanding of the company's operations. So because you have those, that that that increased number of data points, more and more investors are starting to incorporate these non financial factors into their investment decision. What's been really interesting is there's quite a lot of academic evidence to suggest, if you invest in companies that have higher scores from an ESG reason, from ESG perspective, then often you're able to generate stronger financial returns. So higher share price performance. The reason for that is, if the company is managing its environmental risks well, the governance risk well, and the social risk well, it's likely to be an indicator that the company is better managed, and of course, better run businesses generate stronger returns for shareholders over the long term.

Roy Thompson : 5:38

Absolutely. So So I guess, you know, when you start looking at some of these data points you referenced there, and I'm aware of some of those. So, you know, many people would think of as I say for things like climate change, that probably, deforestation, some of those things would come out at the forefront of most people's minds. But what you're saying is that runs deeper than that, and it was goes through to the governance of the company, that the board that's in place, the remuneration structure. So all in all, it's about making good decisions across the whole of the company. Is there, you mentioned, there's quite a lot of academic studies there that would show, this gives a bit of a plus side for the investor, where are they sourcing that data from? And how historic is this now looking? So, so how strong is that evidence that's starting to come through?

Phoebe Stone : 6:32

So one of the studies I often most often refer people to is a meta study. So it's a study of studies. So it amalgamates over 250 different studies on this subject matter, because there's an awful lot of people doing analysis on this. And what this meta study does is shows the relationship between all these studies and the outcome. You can actually go back as far as two decades on this, particularly on the governance side and you do raise an important point, maybe the environmental data or the social data isn't as as long term, but certainly the governance data very much is and a lot of that information is actually in published accounts of companies. So the academic evidence does go back. And there's an awful lot of it around. So I can always send you the study of studies for the show notes for this podcast, if that's useful.

Roy Thompson : 7:26

That would be much appreciated. I guess, a cynic might say, Well, you know, if I'm running a bank or something of that nature, the consequences of my carbon footprint on the surface might look fairly minimal. I could score quite nicely from an E, S and G perspective, because I'm concerned about my carbon footprint, but actually, from a profitability point of view, how does that really impact me. So you're able to give perhaps a bit of an example of how that might look and why that actually is important.

Phoebe Stone : 8:01

Yeah, absolutely. So carbon emissions can be split into scope one, two, and three. And without getting in too much granular detail, scope one and two is what's ordinarily published today. And in fact, only 10% of companies publish scopes three. Scope three is looking further than just operations. It's looking at things like business travel, which to an investment bank might be very, very high. So first of all, it's about understanding exactly what the scope of of the data point is. And fortunately, more and more companies are being pushed by their investors, people like LGT Vestra, to disclose more and more of the data. So the scope three will provide a really an interesting insight into it into a company, like like a bank. But also it's about going one step deeper. So many banks lend money to companies with high carbon intensity, particularly companies in the fossil fuel space whereby the companies are holding on their balance sheets, sites, for example, oil excavation sites, so oil sites that reserves are partially being excavated. What's really interesting and what we've seen evidence of very, very recently is fossil fuel businesses are having to write off large asset groups and these are called stranded assets. They're having to write them off because the burning of these reserves is incompatible with many of the targets that countries have set themselves, for example, the Paris Climate Change Agreement. So the Paris Climate Change Agreement looks to restrict temperature increases to 2% above pre industrialised levels. In fact, if you go one step further and look to reduce temperature rises to 1.5% above pre industrialised levels, 85% of all fossil fuel reserves globally are unburnable. And a big percentage of those reserves are on the balance sheets of fossil fuel companies today. If we think of BP a couple of weeks ago, and we're recording this in July for listeners, so back in June, BP had to write off 17.5 billion Sterling, so pounds, worth of assets, because they they saw them as as unburnable, partially because of things like the Paris Climate Change Agreement, and also the decision by BP to look to try and pivot their business towards a more sustainable transition to a low carbon type model. The bank in your question, as to the very long winded answer, the bank in your question would be lending to these types of businesses. So yes, their scope one and two carbon emissions may be low, but actually the risk within their business model might be much, much larger because these fossil fuel producers might have to write off a lot of stranded assets, and therefore what is their ability to pay back that debt.

Roy Thompson : 11:00

Wow. So I don't think many people listening would think about it in that deeper nature. So it's really insightful to start to understand that this is what's going on at a corporate level with major companies that are listed here in the UK, and of course, internationally. And that's going to have a profound effect moving forward, I would guess. So, do you see a scenario where we we've now entered a place of travel where people are starting to monitor this sort of aspect of their business that will continue and continue ie. there'll be more and more detail available as time goes on?

Phoebe Stone : 11:41

Yeah, I think absolutely. That's the case. What's been really interesting is that the presence of COVID-19 has accelerated the interest in this. I think there's a lot of concern from people inside and outside the sustainable investment industry that as soon as we approached an economic crash that all interest in this space will disappear out of the window because people have other things to focus on and worry about when in fact, the complete opposite has happened. The fact that there is now so much focus on sustainability, on the environment, on social issues, as a result of this economic turmoil that we're going through, I think has placed sustainability as exposure of data or as a point of strategic difference really, very high up on many corporate agendas. Many businesses now have a Chief Sustainability Officer that reports directly into the CEO and as a sustainable investor if that Chief Sustainability Officer doesn't report into the board, then that's a big red flag. If, for example, they report into a subsidiary of the business. But many, many companies are taking these issues extremely seriously and even more seriously than they did at the end of last year.

Roy Thompson : 12:53

It's amazing, I guess, things like social media and where you can be called out if you're a Board member. The last thing you want is your company to be called out on social media because of, you know, malpractice or not following some of these guidelines, but, you know, desires of the potential investors, is that right?

Phoebe Stone : 13:14

Yeah, social media is one big driver, but also the markets themselves. So investors are increasingly demanding higher and higher standards from corporates, let's think of a major fast moving consumer goods business. If they have signal that they're only going to be using sustainable palm oil and all of their products, the competitors around them that haven't gone to that, at that length, they're going to be in the spotlight. And that's a real life example that we've seen play out over the last couple of years. There is a business that spent six years making sure that all palm oil that's used all of the products, so this company produces thousands of products, all comes from sustainable sources. I.e. plantations that have been there for many, many years and are not causing deforestation. But that's put a lot of pressure on everyone around it in terms of the businesses in that peer group. And the peer group businesses that haven't gone to those lengths have seen share price pressure. And if there's anything that makes a board and the boardroom set up and think and listen, its impact on share price, so you can really see investors making changes and moving the needle with regards to how these corporates are operating because of their disinvestment in companies that aren't taking these issues seriously.

Roy Thompson : 14:31

Mm hmm. So so when you start analyzing companies from this point of, you get these data feeds from a variety of different areas. What do you do to then overlay the good companies that have a positive ESG standing, compared to the companies that have still got a positive ESG standing but their financial performance perhaps doesn't match up? How do you differentiate against the two?

Phoebe Stone : 14:56

The first thing that you can see on my job description is the fact I am an Investment Manager. So first and foremost, I'm looking to invest in strong businesses, strong investments that are going to generate good financial return. And more than that strong risk adjusted return for your clients. But the byproduct of that, if you're investing in the right businesses can be a focus on sustainable companies. So it's not a trade off between sustainability and return. It's about finding the companies that are financially viable, and have really focused on minimizing the environmental and social impacts of their operations, or, in fact, businesses that are looking to actively solve a major global challenge. And we haven't spoken much time spent much time talking about this, but the kind of impact investment space where the companies could be actively looking to provide solutions to climate change, or resource depletion, or health care and education, and that's an area there's a lot of focus on and something that we very much utilised in the portfolios that we run.

Roy Thompson : 14:57

I think that's good to hear. Because you know, that probably is. Corporate governance is rarely going to be very exciting for people. It's quite nice to know that where they're investing people are following good practice, but actually things that we think of this podcast called the Retirement Gym, you know, we have increasing longevity, what we want is sustainable investments for that longevity of lifetime. And for assets we pass on to our children. I'd guess within that some of this impactful investing is going to then end up being the new big companies that we see in the next 20-30 years. So is that right, is that when we start looking at impactful investing, is that what you're looking for?

Phoebe Stone : 16:43

Yeah, I think that's absolutely right. So the impact investment companies today do tend to be more of the small and mid cap space, so slightly more niche. But I think you're absolutely right. In the next 20 years, those companies will be the mega cap names that we're so familiar with today. Those are the companies that are facilitating recycling of plastic or recycling of water, an extremely important theme that doesn't really get much airtime, but of course has a massive financial benefit as well. And then on the social perspective, companies providing education or access to financial services to many parts of the world that you otherwise wouldn't have access to a bank account. These companies are held in the portfolios today, I think those will be the ones that grow and become increasingly dominant over the next couple of decades.

Roy Thompson : 17:33

Do you break down your investment philosophy? So you've got more in that impactful space or more in the governance space? Or do you look at it across the whole spectrum of the ESG headline?

Phoebe Stone : 17:47

So the portfolio can be split to someone like me, who runs it, between sustainable and impactful and this is getting to quite granular detail, but the sustainable bit is companies that are, the end product or service might just be a computer or a pair of trainers. But that company is producing what they're producing in the most sustainable way possible given their circumstances. So those companies tend to be referred to as sustainable leaders or companies scoring well on an ESG perspective. So there's absolutely a place for those types of companies in the portfolio. Because that investing in those types of businesses does drive change, like I've mentioned that example earlier, whereby you can force the hand of affords given the share price movements, but there is exposure to the impact space, it is it is smaller. Given the fact it's slightly more niche, the companies tend to be small and mid cap so larger than your mega cap names in the equity space, and then within the bond space, we can get exposure by a specific bond funds, investing in things like green bonds and social bonds. Green bonds and social bonds are bonds that are issued by a company or by country. But the sole proceeds of those bonds have to be ring fenced towards a specific project. So effectively a corporate goes to market and says I want to borrow, let's say, a billion dollars. And I can be clear with you that this billion dollars is only going to be spent on the building of a wind farm. So as an investor, I know exactly where my money is going. It's going towards that wind farm project, I get reports on how that wind farm project is going every year, and actually how much renewable energy has been generated from that project. So it's very, very pure, but it's only a small part of the fixed income market today. So we only have a small exposure in portfolios to those types of investments,

Roy Thompson : 19:44

Okay, so you're matching your exposure to these different investments to in essence, the risk that they carry and you might have a slightly smaller element of the higher risk offerings and a larger element of the lower risk traditional bigger companies that you might, a consumer, might recognise, but where they're showing good governance.

Phoebe Stone : 20:06

Yeah, exactly and the social and environmental aspects as well. Yes.

Roy Thompson : 20:10

Yeah. And are you finding from this that there's a particular, so again, if you think of this podcast as the Retirement Gym, you might traditionally find this sort of investing is done by, you know, people might call them millennials. But my experience is now that this is becoming a far wider thing, and it's actually, generation is not an issue. You know, it's all people have started showing interest in this type of investing. Is that is that your experience?

Phoebe Stone : 20:37

Absolutely. And that's what a lot of the evidence shows as well whether survey evidence or evidence in terms of people investing actual money in this space. I think what's really interesting is that people are approaching retirement or in retirement are starting to think about what their money is producing, other than just financial return. And if they are thinking about passing some of that money on. Yes, its monetary inheritance. But what kind of world are they leaving behind? What kind of world do they want their children or grandchildren or great grandchildren to inherit? I think investing in companies that are strong from a financial perspective, and also behaving responsibly and sustainably is increasingly important to people, particularly now that it's quite clear that you don't necessary have to sacrifice investment returns for looking to position your portfolio in this way.

Roy Thompson : 21:28

Yeah, Phoebe that's, that's really useful. So you know, I think if we're summarising, good corporate governance, impactful investing, done in the right way, can evidence or can provide some evidence of out performance in terms of returns in certain circumstances. Moreover, if that investment is doing a good thing, we're adding to the sustainability of the world that we live in, which is a positive not necessarily just financially, but actually for for us all as human beings as well, and actually, as a private investor, I have a choice about whether I want to invest in those sort of areas. And that's certainly something that you would encourage a conversation with a financial advisor about to open up and help understand some of the points that we've spoken about today. Is that a sort of a fair summary of what we've gone through?

Phoebe Stone : 22:21

Yeah, absolutely. I think there's increasing numbers of people wanting to have that conversation.

Roy Thompson : 22:25

Good. Thank you very much for your time. Before you go. I've got three questions for you that that we've asked people who've come on, and so they're not too strenuous, so hopefully you'll be okay with them. But favorite day of the week?

Phoebe Stone : 22:40

Oh, good one. Um probably Wednesday because I'm in my flow. I like working. So I'm actually going to choose a weekday. I'm in my flow with work but then not exhausted by the end of the week.

Roy Thompson : 22:54

So you're the first person whose done a non weekend date. I was pretty convinced no one was going to come up with between Monday and Thursday but you've gone slap bang in the middle of the week there, Phoebe.

Phoebe Stone : 23:13

Unusual maybe yeah.

Roy Thompson : 23:15

Commitment to the cause. So one piece of advice you'd give to someone down the pub?

Phoebe Stone : 23:20

Down the pub? Right now? Get in the queue.

Roy Thompson : 23:27

Get in the queue or when you're at the bar in normal times.

Phoebe Stone : 23:31

No to get in the queue, they need to get in the queue to get their beer.

Roy Thompson : 23:34

That's good advice. Yes, stay two metres apart or a meter or whatever.

Phoebe Stone : 23:38

Get away from me.

Roy Thompson : 23:40

And a bit macarbe, but what's your funeral song?

Phoebe Stone : 23:45

Oh, okay, I don't know if this is, what it says about me. But I don't know if you're a David Bowie fan. But he has a song called five years. Do you know that one?

Roy Thompson : 24:00

I don't personally, no.

Phoebe Stone : 24:01

Oh, it's on the Ziggy Stardust album.

Roy Thompson : 24:04

Okay, that's the one. Yeah, that's good. Bowie, that's a big name. So I'm sure there's gonna be many people listening who can recognize that. So good stuff. Phoebe, thanks for joining us and thanks for going through that I think it's really insightful and the information we're starting to get through on this form of investing is you know, is ever growing and becoming more popular. If anyone listening wishes to go through that in more detail, please contact us at MHA Carpenter Box Financial Advisors and we'd be more than happy to help. Thanks very much. Thanks for listening today. If you're concerned about the impact your investments or your pensions are making on the world and wish to consider a sustainable approach with sound governance, you can find more information at lgtvestra.com or carpenterboxfa.com where you can always find a link through to one of our financial advisors who would be more than happy to talk to you in more detail about how this affects your own arrangements. For now, thanks very much. Transcribed by https://otter.ai