CIO Insights Special

27 Pages·2017·1.97 MB·English

CIO Insights Special
Act today to ensure our future – Understanding ESG
APAC Edition – November 2017
CIO Insights Special
Act today to ensure our future
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
Uherenin.d Paest Presrfotramannced anidn fogrec aEstsS areG not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 1
CIO Insights Special
Act today to ensure our future – Understanding ESG
ESG Special
Authors:
01 Sustainability – beyond 02 Defining sustainable
Markus Müller philanthropy investment
Global Head CIO Office – Environmental
– Social
Enrico Börger – (Corporate) Governance
Financial Writer
03 The expectations of investors 04 The five levels of ESG approach
and the main investment – Exclusions
vehicles – Adherence to norms
– Time to shake off the – Best in class approach
perceptions of the past – Thematic investments
– Historic milestones – Engagement & Impact investing
– Demographic shifts among
investors and their effects on
investors’ expectations
– The investment vehicles
05 Opportunities in Sustainable 06 The financial return of ESG
Investment Vehicles strategies and the role of
Guest comment by the German specialist research agencies
Ministry of the Environment
07 The caveats and the “ashes to 08 Conclusion
ashes” analysis
Preface
Investing on the basis of environmental, social and governance factors – or ESG for
short – is not new. We have, for example, been able to invest in multiple socially-
responsible stock indices for almost two decades. Concerns about individual firms’
impact on the environment and sustainability in general go back much further.
ESG investing is now, however, increasingly centre-stage. In part this is because digital
news flow has made investors more continuously aware of the underlying issues. The
debate around climate change and the Paris Accord (and, most recently, the COP23
meeting held in Germany) has contributed to this.
Christian Nolting
Global CIO But I think that the rise of ESG investing also reflects two key changes in investor
behaviour and aspirations. First, many private investors do not want a passive
approach to investing: instead they want to use their investment knowledge to use
their wealth in an active, objective-driven way. Second, there is a growing realisation
that ESG is not just a step away from philanthropy. Private and institutional investors
see that socially-responsible long term aims can be combined with attractive short and
medium-term returns.
This report, which includes a contribution from the German Environment Agency, aims
to provide an overview of the various types of ESG investing, along with opportunities
and risks. I believe that this subject can only grow in importance.
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 2
CIO Insights Special
Act today to ensure our future – Understanding ESG
01
Sustainability –
beyond philanthropy
“Don’t fell more trees than can grow as it was called, was the US Pioneer
back“. Thus spoke nobleman and Fund, launched in 1928 with the aim
ecologist Carl von Carlowitz in 1713 in of declining to invest in alcohol and
his treaty on “Sylvicultura oeconomica”, tobacco industries on the grounds
unwittingly laying the foundation for of their negative effect on human
what was later going to be known as health. Nearly half a century later, two
sustainable investing. Methodist ministers launched the Pax
World Fund, an investment fund that
At the time, the king‘s ore and silver excluded from its investment universe
smelteries were burning through a shares deemed ethically unfit, focusing
considerable amount of timber in order instead on securities of companies
to produce armories and weapons for the that met certain criteria about the
king‘s army, as well as producing building treatment of their employees and the
material for infrastructure projects. The environment. In 1972 a United Nations
ensuing deforestation caused an extreme conference in Stockholm on the human
shortage of timber that prompted Carl environment first discussed the tradeoffs
von Carlowitz to question the sense of and the challenges of sustainability,
depleting natural resources for short- economic growth and development for
term gain. In 1987, the Brundtland our planet. The same year, the Club of
report on the subject reiterated this very Rome published the book “Limits to
same point by defining that sustainable Growth”. In 1980, two UN agencies
development “means that the present published a paper co-authored by the
generation satisfies its needs, without World Wildlife Fund (WWF) titled “ Living
endangering future generations Resource Conservation for Sustainable
satisfying their needs.“ Development“. It was the first
international document on living resource
Similarly, in the early 19th century, conservation produced with inputs
the German scientist Alexander von from governments, non-governmental
Humboldt noticed during his journey organizations.
through the South American rainforests
that the Valencia lake in Venezuela In 1990 the Domini 400 Social Index
had started drying up since nearby became the world‘s first “socially
woodlands had been felled in order responsible“ stock index, aimed at
to obtain arable land. Indeed, he first helping socially conscious investors
established a link between deforestation weigh social and environmental factors
and droughts, going as far as inventing in their investment choices by providing
an energy-efficient fireplace to counter them with a benchmark. This index is
the problem. today calculated by MSCI (MSCI KLD
400 Social Index) and is a leading index
Even before Carl von Carlowitz‘s time, for socially responsible investments in
however, we have evidence of what is the United States.
known today as responsible and ethical
investment practices. In the 17th century In general terms, however, the quest
the Quakers in the newly established for sustainability is probably as old as
territories of Northern America decided mankind itself. The ancient Romans
to refuse making a profit from war were known to store wine and water
and from the slave trade, which were in amphorae made of terracotta and
incompatible with their ethical principles. ceramic. At the end of their useful lives,
these amphorae were pounded into
In modern times, the first recorded chips and and converted into “opus
“responsible“ investment vehicle, signinum“, a type of concrete used as
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 3
CIO Insights Special
Act today to ensure our future – Understanding ESG
building material. In AD 77 Pliny the agricultural communities throughout the environmental, social and governance
Elder describes in his Natural History middle ages, and survives to this day. (“ESG“) considerations and questions
how broken pottery “beaten to powder, how each economic activity contributes
and tempered with lime, becomes more What is new about sustainability in our to human welfare for current and future
solid and durable than other substances age is the consistent application of generations. Typical aspects taken into
of a similar nature; forming the cement these concepts to investment strategies consideration are the protection of
known as the “Signine“ composition, so and the elevation of sustainability to an human dignity, the observance of certain
extensively employed for even making investment theme which, as we will see, labour and environmental standards as
the pavements of houses“. Fragments is being articulated in many different well as the aforementioned cautious use
of recycled amphorae have been found ways. The starting point is the realization of resources.
in aqueducts and roads, revealing that a that any sort of investment can have
considerable part of ancient Rome was unintended side effects, therefore It is important to differentiate between
built on the basis of recycled materials, to investments are not ethically neutral. As sustainable investment strategies
a degree far exceeding what is achieved an example, even if a certain investment and philanthropy. The latter consists
in this regard in our times. However, pursues a worthy goal, it may use up of donating funds to a worthy cause
the technique for reusing second-hand resources that need to be preserved without any expectation of financial
amphorae predates even the ancient for future generations. Similarly, it is gain. Hence, philanthropy by definition
Romans; it is known to have originated in important to take into account what is not an investment strategy, it is a
North Africa some time before 256 BC. is known as the externalisation of form of charitable giving. The present
costs, i.e. the effects of an economic report focuses exclusively on investment
As the Brundtland report suggests, at activity on third parties, who may suffer strategies, defining sustainable
its heart sustainability is the pursuit from its negative side effects without investments as a pursuit of one or more
of a healthy balance between short- participating in the financial return of the following objectives: 1) achieve
term profit and long-term preservation that is being generated. We therefore a positive environmental or social
of resources. Intuitively, mankind has understand sustainability not just as the impact alongside financial returns; 2)
known this and for a long time. Shared pursuit of noble goals but also as the align investments with personal values;
ownership of grazing fields that are appreciation of the direct and indirect and 3) improve portfolio risk/return
subject to strict guidelines to prevent effects of an investment on other people characteristics. In short, sustainability
future depletion of the soil‘s nourishing and on the environment. To this end, can be defined as a fundamental step
properties has been common in sustainable investing encompasses beyond philanthropy.
02
Defining sustainable
investment
Environmental, social, standards, such as the production
governance aspects of chemical weapons, or business
Roughly speaking, we differentiate practices such as child labor, to quote
between environmental, social and two prominent examples. Of course, the
governance goals when talking about definition of what is ethical is subjective
sustainable or responsible investments, and can vary between countries, cultures
hence the acronym “ESG“ which has and people. However, roughly speaking
imposed itself as the most common “ethical“ investment is commonly
term in this regard. At the most basic understood to involve the protection of
level, social and ethical responsibility human dignity and the abstention from
means an abstention from involvement practices that are detrimental to human
in any industry or product line that is and societal welfare. The most common
either harmful, i.e. polluting or unhealthy implementation of this approach is via
in other ways, or not up to ethical an investment portfolio that filters out
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 4
CIO Insights Special
Act today to ensure our future – Understanding ESG
securities linked to companies that
don‘t fulfill these standards. Specialised Figure 1:
analysts research the product mix ESG: An acronym with many meanings
and the business practices of each A wide range of approaches and goals
corporation in the investable universe Source: Schroders, Deutsche Bank Wealth Management.
in order to rank them according to a set
of criteria, with the aim of assessing Top down, issue driven
their social, ethical and environmental
impact on society and nature. Thus,
an overlay can be created that filters
out any security that doesn‘t fit in with
Thematic
these standards, obtaining an equity or investing
bond portfolio that can be certified to be
consistent with the desired conditions. Screened
This approach represents the entry investments ESG
level of responsible investing because Integration
it merely excludes irresponsible or
unethical practices, rather than being
Governance
an active quest for making a positive and active
contribution to society. While it still is ownership
Social benefits Performance benefits
the most common approach to ESG
(value) (value)
investing, exclusion policies don‘t
represent the main object of this paper, Best-in-class
responsible
as we are more interested in discussing
investments
investment strategies that aim to
make a positive impact by pursuing
Impact
worthy causes rather than by excluding
investing
unworthy ones.
One level up from exclusion policies there
is the active approach: instead of thinking
in terms of exclusions, it thinks in terms Bottom up, company driven
of which investment opportunities can be
found that make a positive contribution
to society while at the same time ethical and socially responsible principles or the social context it operates in, and
generating positive returns. The key can be applied, namely corporate the more it pursues long-term goals in
to making a positive contribution is to governance. Even when a public harmony with its environment, the more
identify promising but untapped areas listed company is not involved in any sustainable its revenues are likely to
for sustainable development that are business or product line that may offer be in the long term. This is the concept
currently overlooked, or whose potential potential for improvement in terms of the “going concern“, the long-term
is not sufficiently appreciated by existing
investment strategies. This implies a
certain degree of risk that is inherent
At heart, sustainability is the pursuit of a healthy
in any innovative initiative, but at the
same time offers the chance to develop
balance between short-term profit and long-term
revenue generating markets or business
sectors that benefit all the stakeholders
preservation of resources.
along the value chain. A typical example
is microfinance, which has exploited the
innovative potential of applying a tried
and tested business model (start-up
financing) to a previously overlooked of ethical or social responsibility, the commitment to keep the company out of
market, i.e. self-employed farmers and way in which the corporation itself is trouble by adopting a long-term vision
artisans in developing countries with no governed matters a great deal, both in about its business practices, the sectors
access to mainstream financial service terms of business ethics and in terms it operates in and its staff. Included is a
providers. of the sustainability of its revenues. The commitment to acting in the best interest
underlying assumption is that the more of all stakeholders of the company,
Apart from these visible implementations an enterprise abstains from short-term shareholders, staff and customers, in
there is another, subtler area where gains at the expense of the environment a way that assures meeting the long-
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 5
CIO Insights Special
Act today to ensure our future – Understanding ESG
term requirements of each. Investment meaningful percentage of voting rights regardless of the industry or business
managers who specialise in analysing in the shareholder assembly have the sector in which the company operates.
the corporate governance of public clout to actively influence a company‘s An easily overlooked but important part
listed companies can identify practices management board, thereby being of this is the avoidance of regulatory
and principles that promise to ensure able to steer key corporate decisions in sanctions, reputational damage and
long-term value creation independently line with certain principles of socially lawsuits that a socially responsible
of which business a company is in, responsible corporate governance. and sustainable approach to corporate
unlocking value for investors that is Again, this offers the opportunity to governance is meant to facilitate.
not visible otherwise. Additionally, unlock shareholder value in line with
large investment funds that control a a sustainable investment approach,
Figure 2:
ESG keywords categorized
Source: MSCI ESG Research, Sustainalytics.
Hazardous waste management Human capital management Anti-competitive practices
Board structure/size Biodiversity/land use Fair trade products Employee relations
Labour management Water management Anti-takeover measures Working conditions
Ownership structure Business ethics Responsible marketing and R&D Shareholder rights
Biodiversity programmes Advertising ethics Weather events Clean technology
Corruption and instability Supply chain management Anti-money laundering policy
Gender diversity of board Green buildings Community relations Union relationships
Environmental Social Governance
Corporate governance Customer relations/product Diversity and discrimination
Employee safety Carbon emissions Accountability Energy efficiency
Climate change risks Executive compensation schemes Recycled material use
Controversial business Compensation disclosure Product safety Anti-bribery policy
Bribery and corruption Waste and recycling Diversity issues Raw material sourcing
Regulatory/legal risks CEO duality Energy usage Human rights policy
Health and safety Natural resource use Transparency Voting procedures
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 6
CIO Insights Special
Act today to ensure our future – Understanding ESG
03
The expectations of
investors and the main
investment vehicles
Time to shake off the nefarious effects on the environment that
Figure 3: perceptions of the past persist to this day. Another prominent
A willingness to invest for longer in ESG In the past, ESG approaches have all example was the oil spill of the tanker
investments too often been seen as compromising Exxon Valdez in 1989 that lead to the
Confirming our focus is right returns and standing in the way of spillage of over 40 million litres of crude
Source: Schroders Global Investor Study, profit maximisation. In this view, ESG oil into the pristine waters of Alaska in
conducted between 30 March and 25 April investments are considered to be one what represents the region‘s most tragic
2016. step away from charitable donations, a environmental disaster in history. More
sort of hybrid between investment and recently, an altogether different scandal
philanthropy. The fact that foundations has served to highlight that it is not just
and churches have been early adpoters the environment and local populations
of ESG-based investment strategies has that can suffer from a lack of proper
only reinforced these views. However, corporate governance but also the
these views no longer correspond to investors themselves, independently of
reality, if they ever did. Far from being where they are based. The bankruptcy
a contradiction to positive investment of Enron in 2001, a once highly regarded
3.2 years
returns, as mentioned above, ESG American blue chip stock, wiped out
the average period consumers usually strategies offer the potential for billions of equity and debt holdings
leave money in an investment (excluding unlocking otherwise untapped value within a few days for reasons that can
property and pensions) while at the same time helping to achieve be attributed directly to grave faults in
more sustainable, long-term revenue corporate governance and oversight.
flows. Additionally, these strategies This case has highlighted the benefit
enable investors at the very least to of corporate governance in reducing
avoid financing business practices they portfolio risk: well-governed companies
don‘t agree with, and possibly to make a are less likely to cause bad surprises
positive impact on society by achieving for investors because financial and
particular ethical goals or improve human reputational problems are harder to hide
welfare, all while generating positive if corporate oversight is strong.
returns on their invested capital. The
2.1 years
spectrum is very broad and deserves Changes in the attitudes and
the average number of additional years more detailed analysis. the expectations of investors,
that investors would hold ESG investments including demographic
compared to standard investments Historic milestones changes.
Before delving into the matter further, There are additional factors that have
it is worth looking at investors‘ helped ESG considerations become
expectations and opinions on the subject. more popular among investors. On the
During the 1980s, a succession of high one hand, growing levels of investor
profile corporate disasters made the education in financial matters have
public aware of the risks associated increased the willingness to be actively
with lack of discipline in environmental involved in financial decisions by people
and governance standards. Some of who in the past may have been happy
the most dramatic cases include the to delegate these entirely to their
82%
disaster in the Indian town of Bhopal that advisers. Secondly, institutional investors
of investors said they would hold an ESG happend in 1984, when 40 tons of highly have become more concerned about
investment for longer than a standard toxic chemicals leaked out of a factory sustainability in a way that mirrors the
investment owned by Union Carbide, with deadly general shift in attitude from the sole
consequences for the population and quest for “quantity“ in the post-war
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 7
CIO Insights Special
Act today to ensure our future – Understanding ESG
economic expansion to the aim for
“quality“ in growth that can be observed Figure 4:
in all aspects of society and that goes Motivation for social impact investing among respondents who own or are
hand in hand with rising prosperity. interested in owning1
Additionally, public opinion surveys 1 2016 U.S. Trust Insights on Wealth and Worth – Annual survey of high-net-worth and
keep showing a growing interest in ultra-high-net-worth Americans
environmentally and socially responsible
investments by younger generations,
even though these surveys need to be
40%
taken with a pinch of salt because an
Believe companies that
interest to invest ethically and actual
are good corporate
53%
investments into ethical vehicles are citizens are less susceptible
two rather different things. Moreover, as to business risks Belief that corporate America
38% should be held accountable
the “millennial“ generation is just about for its actions
Believe companies
entering adulthood, in aggregate it will
that have a positive
take decades to acquire the investible impact have better
financial performance
assets needed to have an impact on
financial markets similar to the clout of
50%
the current “baby boomer“ generation,
except in those cases where the younger Strong feelings for certain
social, environmental or
generations are the recipients of governance issues
inheritances in the shape of liquid assets,
49% 54%
a trend that acccording to actuarial
studies is set to increase. Want to make a positive It’s the right thing to do
impact on the world
Another reason that drives the search for
sustainable investment products is the
sheer growth of the world population that
forces us to look for new ways to limit
the population‘s impact on the planet.
Feeding more people requires an increase
in food production which, other things
being equal, requires more agricultural
land, more displacement of native plants
and animal species and more pollution.
Similarly, the rapid advancement in living
standards causes more and more people Figure 5:
to live in metropolitan areas, especially in How important are each of the following ESG issues to your choice of
emerging Asia, which in turn confronts investments? (Scores out of 10)
humanity with new environmental Source: Schroders Global Investor Survey (2016) - Global Consumers.
challenges.
5
Concerns about global warming
4 6
represent yet another pillar of
environmentally sustainable investment,
especially in view of governmental 3 7
targets for limits to CO2 production
and for a containment of raising
temperatures. A final pillar in this 2
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of the top five risks in terms of likelihood 0 G G P P P 0 10 10
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 8
CIO Insights Special
Act today to ensure our future – Understanding ESG
are considered to be environmental. For instance, one firm that invests in and still partly untapped. Moving away
pollution-reducing technology may from stocks and bonds, the investment
The investment vehicles at the same time own a division that vehicles become rather less liquid.
Intituitively, most investors think itself constributes to pollution. Bonds, Private equity is a form of investment
of equities when considering ESG on the other hand, can be issued in a that is extremely well suited to targeted
investments. In the past, it was indeed much more targeted way, as they can be ESG aspects thanks to its flexibility.
the case that the bulk of sustainable directed at financing specific projects or However, it is by definition illiquid
and responsible investment strategies specific market niches without carrying and hence not suitable for all types of
focused on equities, especially within the “baggage“ of a complex enterprise investor, at least as a direct investment.
exclusion strategies. Even now, much with them. Additionally, the yield of a It becomes more accessible if it is
of the attention of rating agencies bond can be linked to an infinite range offered as a fund on which a financial
that focus on assessing companies‘ of criteria, indices and ventures so as to service provider guarantees a certain
adherence to ESG standards and the allow targeting fixed income instruments level of liquidity. On the other side of
sustainability of their business practices very specifically to certain endeavours the spectrum we are seeing growing
think in terms of the equity market. in a way that is not possible to do with numbers of Exchange Traded Funds
However, a listed company by definition equities. The use of ESG filters on bond (ETFs), which represent the most liquid
tends to be a large entity, which is investments, possibly also mapping and most tradable type of mutual fund,
inevitably involved in more than one sovereign issuers, completes the picture specializing in ESG investments. While
single project and often in more than for ESG-conscious investors, giving for the most part these funds pursue
a single line of business. Indeed, most them the possibility to choose integrated exclusion strategies, it is to be expected
well-known stocks, especially those and balanced approaches according to that over time these retail investment
included in the main market indices, their individual risk profiles. This step vehicles will be able to move into more
are complex creatures whose impact represents the coming of age of ESG active and more targeted types of ESG
on the environment and on society is investments. investment, making the sector more
wide-ranging, making it difficult to pass easily accessible to private investors.
a judgement on the contrasting positive The potential of fixed income instruments
and negative types of impact they have. for ESG investments is therefore vast
Figure 6:
Top 5 Global Risks in Terms of Impact
Source: World Economic Forum “The matrix of top 5 risks from 2007 to 2017”.
1st 2nd 3rd 4th 5th
Failure of climate
Weapons of mass Extreme weather Major natural
Water crises change mitigation
destruction events disasters
and adaption
2017
Extreme energy
Major systematic Chronic financial
Water supply crises Food shortage crises and agriculture
financial failure imbalance
price volatility
2012
Retrenchment from Interstate and
Asset price collapse Pandemics Oil price shock
globalization civil wars
2007
Environmental Economic Geopolitical Societal
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 9
CIO Insights Special
Act today to ensure our future – Understanding ESG
04
The five levels of
ESG approach
Exclusions each other, rendering them mutually
As mentioned before, exclusions exclusive: either one chooses the original
represent the entry level of ESG investment strategy at the cost of owning
investment, being the simplest way to a portoflio that rewards unsustainable
implement ESG criteria in a portfolio. At practices, or one has a sustainable
the most basic level, an exclusion policy portfolio at the cost of reducing the
takes any existing portfolio and filters expected return. Investors who find
out securities linked to companies that neither of these two options appealing
don‘t conform to a certain set of criteria, are better served by one of the following
be it ethical or environmental concerns approaches to sustainable investments.
or issues linked to lack of sustainability
or corporate governance. Firms involved Adherence to norms
in the arms trade or judged to have This is a standardized way of
unethical labour standards are typical constructing a portfolio based on
targets for exclusion. However, this companies‘ adherence to a set of
approach suffers from two flaws: one is industry standards and norms such
financial, one is conceptual. The financial as international “SRI“ guidelines and
flaw is that any existing investment the United Nations principles. It is a
portfolio is inevitably going to be “positive“ approach to ESG investing
because the portfolios are built according
to ESG criteria from the start, rather
than being an overlay to an existing
The sheer growth of the world population forces
strategy. On the plus side, taking well-
known norms as criteria for the inclusion
us to look for new ways to limit the population‘s
into the investment portfolios allows
for transparency and consistency. On
impact on the planet.
the other hand, restricting oneself
to such norms as the only criteria for
defining the investment universe limits
the choice of investable securities to
compromised by removing a certain part those of generally larger companies that
of its investment universe, for certainly have taken the trouble to be certified by
each security was included in the first official agencies and institutions. While
place for some good reason. In the case this approach can lead to good results,
of passive strategies that track a market its shortcoming is that smaller companies
benchmark, taking out certain securities for whom a formal certification is too
will increase the portfolio‘s tracking onerous or simply too laborious will
error. Conceptually, the flaw is that it‘s be missed out. Given that small and
a negative approach to ESG criteria: nimble companies are often the most
one tries to do good not by adding to interesting players in terms of innovative
the investment process but by taking approaches to sustainability, this matters.
away from it. Merely eliminating certain Further, while official norms have a
companies from the investment universe role to play in the standardization of
does not represent an active approach minimum requirements and best practice
to sustainability, nor is the underlying benchmarks, an approach that is tilted
message a constructive one: there is no towards “box ticking“ will always be most
reward for exemplary corporate behavior, useful in defining a basic level from which
just the exclusion of the companies to start, rather than the goal to aspire
deemed unethical, a much weaker to. Further, some market participants
approach. Finally, the exclusion strategy fear that an eccessive reliance on formal
pits ESG and return criteria against criteria may stifle the momentum of
Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon
economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined
herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved.
Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect.
CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 10