FINANCE - FUNDS

ESG strategies

Simple vs sophisticated



Rick Lacaille of State Street. Photo credit: State Street

Rick Lacaille of State Street. Photo credit: State Street

Investment funds have several different strategies for meeting environmental, social and governance (ESG) objectives. Which ones work best? Delano asked Rick Lacaille, senior investment advisor at the banking giant State Street.

Fund managers can take a number of approaches--such as negative screening or positive screening--to meet ESG goals. So what tops the list? Negative screening is “the one that dominates and will dominate,” says Lacaille. But a better question is “What is the future state?”

His answer: “The future state is a more sophisticated version of ESG integration. What do we mean by ESG integration? If I’m a consumer goods analyst working for an active fund manager, and I’m looking at a number of companies in the consumer goods area, I’m thinking to myself, ‘how are they going to grow their revenue and their earnings in the next three to five years, or even longer? What’s sustainable? What practices do they have?’ And I think that extends naturally into the way that they’re addressing environmental management, human capital, a whole raft of things. Now five years ago, ten years ago, that consumer analyst probably wouldn’t have looked too much at that issue. I think, now, it will be unusual for them not to weigh those things in the balance. And I think there’s a generational shift in the asset management industry, in which the younger participants, to put it bluntly--but there are exceptions to this--people who have come up more recently through the CFA programme, they’re aware that culture, society is changing, and their focus has changed as well. So I think that’s where the future lies in terms of best practice.”

Simplistic solution

Negative screening excludes a negative factor like coal or tobacco from a fund. The strategy is “simple,” according to Lacaille. “They have that virtue. And they’re simple for the consumer to understand: ‘I definitely won’t own companies in that area.’ I think that they’re not always the best way of dealing with issues.” Not owning shares will not shut down the company or sector, he reckons.

“I think the best approach, which many have adopted, is make the right financial decision about whether it is too risky to own that company. But if you do own it, engage with the company about what you see as the future for their disclosure and future operating model. I think that’s a much more responsible way of dealing with some of the most controversial aspects, even climate, where I think it’s been successful. It’s a little bit harder to articulate as a value proposition for the consumer than a simple thing as saying, ‘right, we won’t have fossil fuel companies in the portfolio’.”

That is why Lacaille believes “the way forward is really much more sophisticated ESG integration”.

Stepping up ESG integration

What would be more sophisticated about it? “Well, firstly, better research and training. So understanding what’s material, if you’re an analyst, is in many ways pretty obvious. If you’re an analyst in the cement business, and you think there’s going to be carbon pricing, you need to make sure that you’re positioned in low carbon cement companies, or those that are adopting it. It’s kind of a no-brainer. But then the interesting question is, is that already in the price, so if the price of those low carbon cement companies is valued much more highly than the dirty ones, then is it going to pay off from the financial perspective, because it’s already in the price? So I think the ESG integration requires you to look at that trade-off. I could still own a brown asset, and by engaging with them, make it greener. And if I’m buying it more cheaply, well, that’s a pretty attractive combination.”