ESG – Three guiding principles
As our approach to sustainable investing has evolved, we have distilled three key principles that guide our thinking on investing based on environmental, social and governance (ESG) considerations:
1. Assessment of ESG factors is an integral part of a robust investment process, rather than a distinct investment discipline.
At the heart of this is our firm belief that incorporating ESG factors into the investment process equips investors with a fuller picture of the risks and opportunities faced by businesses and governments. This better positions investors to evaluate the risks and opportunities associated with any investment. Incorporating ESG factors into the investment process broadens the scope of information considered, contributing additional insights that improve investment decisions.
At the current nascent stage of ESG integration by the professional investment community, long- term opportunities likely exist due to mispricing of various ESG factors. For instance, the vast majority (87%) of respondents to a recent global survey of investment professionals by members of the Global Sustainable Investment Alliance (GSIA) published in December 2019 do not believe that markets are consistently and correctly pricing climate risks into company and sector valuations.
2. Consideration of ESG factors focuses attention on long term, risk-adjusted investment returns.
Focusing on long term, risk-adjusted investment returns is a key tenet of wealth management.
As stewards of capital for clients who are investing to meet long term financial goals (such as their children’s education and a secure future for their family), we aim to position our clients’ portfolios to benefit from persistent, long term trends, prioritising these over short term headline returns that may be at risk as the costs of poor practices manifest themselves over time. Businesses that manage for the long term consider how they affect the environment and how they treat their stakeholders, including regulators, employees, contractors and suppliers. Such firms are better positioned to generate sustainable returns to shareholders and bondholders over time.
3. ESG investing is not a simple, “yes or no” decision; investors should choose the approach that aligns best with their goals and preferences.
It is critical to understand at the outset that there are a multitude of approaches to sustainable investing. The investment approach ultimately needs to be aligned with investors’ goals and preferences – in the same way that investors’ risk appetite and long term financial goals should guide their optimal portfolio asset mix. Put simply, there is no one-size ESG approach that fits all investors and selecting the correct approach depends on proper identification of individual goals and preferences. Exhibit 1 shows a broad categorisation of the many approaches to ESG investing in practice today.
Importantly, investors who have little interest in investing directly in social enterprises where ESG goals are explicitly prioritised above profits (at the impact investing or philanthropy end of the spectrum shown in Exhibit 1) would still benefit from thoughtful Integration of ESG factors into their investment decisions.
ESG data captures factors important for valuations (such as business reputation) that are not usually reported and provide insights that are not readily observable using conventional financial metrics. Incorporating these considerations into investment analysis supports better investment decision-making by identifying additional sources of risk and return from key non-financial factors.
As higher-quality ESG metrics and industry standards are developed and more ESG-focused products are introduced, we see increasingly greater opportunities for investors to align their portfolios more closely with their own sustainability preferences and goals.
ESG at work – our approach
We adopt a consistent approach to ESG integration that allows our investment specialists, research analysts and portfolio managers to blend the sustainability insights drawn from quantitative ESG data with qualitative analysis and to use their professional judgement to assign suitable weights to this information as they do with conventional financial metrics.
Our approach to sustainable investing is forward-looking and transition-based. When evaluating investment opportunities, we take into account not just the current and past ESG profile of a business or government, but our assessment of its future trajectory.
This means that we look at both current ESG leaders and ESG laggards based on their adoption of clear sustainability-linked goals and meaningful progress towards those goals.
In short, we do not automatically exclude investment opportunities in businesses that are current laggards from an ESG perspective – as long as we assess that these enterprises are likely to adapt successfully to evolving consumer preferences and regulations associated with sustainable economic development paths.
Our approach aligns closely with a well-established concept in conventional investing –that the beaten-down stock or bond of a company that has started on the path to recovery often presents an excellent investment opportunity for patient capital.
This nuanced approach is particularly relevant for investors seeking opportunities in large parts of Asia and other global emerging markets – our Bank’s core areas of expertise – where ESG-focused regulation, data collection and disclosures remain in the early stages.
ESG in Equities
Businesses today are faced with a wide range of ESG factors that present both risks and opportunities that in turn affect equity valuations. Given the idiosyncrasies inherent to each sector, the influence of different ESG factors varies substantially across different sectors. Each of these ESG factors also needs to be analysed through the lens of specific business segments and geographies that individual companies have exposure to.
For instance, regulatory and reputational risks related to carbon emissions, energy consumption, water intensity, pollution and broader environmental degradation are most relevant for traditionally emissions-intensive industries such as fossil fuel production (oil and gas, thermal coal), mining, power generation, autos, and cement and chemicals manufacturing.
Similarly, risks related to sustainable land use, labour practices, employee health and safety, product liability and ethical sourcing tend to be more significant for industries such as agriculture, food production, luxury goods, and garment manufacturing.
Investors should also examine the policies and actions of companies to manage or mitigate their most important risk factors. The time horizon associated with the potential manifestation of risk factors is another key consideration.
Our analysts and portfolio managers today already take these factors into consideration. These are reflected in the assumptions used for financial forecasts, discount rates (when employing a discounted cash flow approach for valuation), and in our qualitative comments in our assessment of companies.
ESG in Fixed Income
In fixed income, our focus on emerging markets presents significant challenges to comprehensive ESG integration. First, a majority of emerging-market countries are at the nascent stage of their ESG journey compared to their developed market counterparts. This in turn means that ESG-focused regulation remains substandard, while ESG disclosures are limited and generally inconsistent across bond issuers. Corporate governance risks, in particular, remain prevalent due to a high number of privately held issuers with limited visibility.
Despite the current laggard position, progress is being made with a deeper focus on ESG factors and increase in awareness and conversations on the topic. Rating agencies, too, are incorporating ESG into their credit ratings. In 2019, Moody’s cited ESG risks as a material credit consideration in one-third of its private sector rating actions, with negative actions of 19% outweighing the 12% positive actions.
We believe investors should take a staged approach to incorporating ESG into their fixed income portfolios. Given the current limitations, an exclusionary approach would be particularly restrictive in fixed income. As such, we suggest that investors keen to increase their portfolio tilt into sustainability look to invest in companies that are superior within their peer group for ESG factors rather than outright exclusion of particular sectors or countries.
Within our current framework, ESG factors flow through key credit considerations and throughout our assessment of credit quality of an issuer. These are considered in our analysis of macro-economic, industry, sector and financial factors. We also highlight relevant risk factors in our communications; paying attention to these can help clients circumvent areas of high risk within their fixed income portfolios. Governance considerations including leadership quality, political stability and the strength of key public institutions and regulators have long been part of our assessment of investments in emerging markets credit.
The path forward
Recent deadly events have highlighted the need for increased action to guard against long-term sustainability risks for businesses and society as a whole. The Covid-19 pandemic sweeping across the world today has exposed the deepening inequality in wealth, living conditions and access to social security, healthcare and daily necessities even in developed economies. The ensuing shutdown of large swathes of the global economy has also resulted in significant operational risks for companies. For many businesses, the integrity and resilience of their supply chains, and the quality of their employee relations and crisis management have suddenly come into sharp focus like never before.
We see the crisis accelerating emerging trends in ESG and we expect the heightened focus on businesses’ environmental and social impact to persist long after the crisis abates. We hope the principles outlined in this paper will help our clients to develop a better understanding of their own ESG views, and to ultimately align their investments more closely with those views.
This material is prepared by Bank of Singapore Limited (Co Reg. No.: 197700866R) (the “Bank”) and is distributed in Singapore by the Bank.
This material does not provide individually tailored investment advice. This material has been prepared for and is intended for general circulation. The contents of this material does not take into account the specific investment objectives, investment experience, financial situation, or particular needs of any particular person. You should independently evaluate the contents of this material, and consider the suitability of any product discussed in this material, taking into account your own specific investment objectives, investment experience, financial situation and particular needs. If in doubt about the contents of this material or the suitability of any product discussed in this material, you should obtain independent financial advice from your own financial or other professional advisers, taking into account your specific investment objectives, investment experience, financial situation and particular needs, before making a commitment to purchase any product.
This material is not and should not be construed as an offer or a solicitation to deal in any product or to enter into any legal relations. You should contact your own licensed representative directly if you are interested in buying or selling any product discussed in this material.
This material is not intended for distribution, publication or use by any person in any jurisdiction outside Singapore, Hong Kong or such other jurisdiction as the Bank may determine in its absolute discretion, where such distribution, publication or use would be contrary to applicable law or would subject the Bank or its related corporations, connected persons, associated persons or affiliates (collectively “Affiliates”) to any licensing, registration or other requirements in such jurisdiction.
The Bank and its Affiliates may have issued other reports, analyses, or other documents expressing views different from the contents of this material, and may provide other advice or make investment decisions that are contrary to the views expressed in this material, and all views expressed in all reports, analyses and documents are subject to change without notice. The Bank and its Affiliates reserve the right to act upon or use the contents of this material at any time, including before its publication.
The author of this material may have discussed the information or views contained in this material with others within or outside the Bank, and the author or such other Bank employees may have already acted on the basis of such information or views (including communicating such information or views to other customers of the Bank).
The Bank, its employees (including those with whom the author may have consulted in the preparation of this material))and discretionary accounts managed by the Bank may have long or short positions (including positions that may be different from or opposing to the views in this material or may be otherwise interested in any of the product(s) (including derivatives thereof) discussed in material, may have acquired such positions at prices and market conditions that are no longer available, may from time to time deal in such product(s) and may have interests different from or adverse to your interests.
The analyst(s) who prepared this material certifies that the opinions contained herein accurately and exclusively reflect his or her views about the securities of the company(ies) and that he or she has taken reasonable care to maintain independence and objectivity in respect of the opinions herein.
The analyst(s) who prepared this material and his/her associates do not have financial interests in the company(ies). Financial interests refer to investments in securities, warrants and/or other derivatives. The analyst(s) receives compensation based on the overall revenues of Bank of Singapore Limited, and no part of his or her compensation was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this material. The reporting line of the analyst(s) is separate from and independent of the business solicitation or marketing departments of Bank of Singapore Limited.
The analyst(s) and his/her associates confirm that they do not serve as directors or officers of the company(ies) and the company(ies)or other third parties have not provided or agreed to provide any compensation or other benefits to the analyst(s) in connection with this material.
An “associate” is defined as (i) the spouse, parent or step-parent, or any minor child (natural or adopted) or minor step-child, or any sibling or step-sibling of the analyst; (ii) the trustee of a trust of which the analyst, his spouse, parent or step-parent, minor child (natural or adopted) or minor step-child, or sibling or step-sibling is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst.
Conflict of Interest Declaration
The Bank is a licensed bank regulated by the Monetary Authority of Singapore in Singapore. Bank of Singapore Limited, Hong Kong Branch (incorporated in Singapore with limited liability), is an Authorized Institution as defined in the Banking Ordinance of Hong Kong (Cap 155), regulated by the Hong Kong Monetary Authority in Hong Kong and a Registered Institution as defined in the Securities and Futures Ordinance of Hong Kong (Cap.571) regulated by the Securities and Futures Commission in Hong Kong. The Bank, its employees and discretionary accounts managed by its Singapore Office may have long or short positions or may be otherwise interested in any of the investment products (including derivatives thereof) referred to in this document and may from time to time dispose of any such investment products. The Bank forms part of the OCBC Group (being for this purpose Oversea-Chinese Banking Corporation Limited (“OCBC Bank”) and its subsidiaries, related and affiliated companies). OCBC Group, their respective directors and/or employees (collectively “Related Persons”) may have interests in the investment products or the issuers mentioned herein. Such interests include effecting transactions in such investment products, and providing broking, investment banking and other financial services to such issuers. OCBC Group and its Related Persons may also be related to, and receive fees from, providers of such investment products. There may be conflicts of interest between OCBC Bank, the Bank, OCBC Investment Research Private Limited, OCBC Securities Private Limited or other members of the OCBC Group and any of the persons or entities mentioned in this report of which the Bank and its analyst(s) are not aware due to OCBC Bank’s Chinese Wall arrangement.
The Bank adheres to a group policy (as revised and updated from time to time) that provides how entities in the OCBC Group manage or eliminate any actual or potential conflicts of interest which may impact the impartiality of research reports issued by any research analyst in the OCBC Group.
If this material pertains to an offer, it may only be offered (i) in Hong Kong, to qualified Private Banking Customers and Professional Investors (as defined under the Securities and Futures Ordinance); (ii) in Singapore, to Accredited Investors (as defined under the Securities and Futures Act 2001); and (iii) in the Dubai International Financial Center, to Professional Clients (as defined under the Dubai Financial Services Authority rules). No other persons may act on the contents of the material.
Where this material relates to structured deposits, this clause applies:
The product is a structured deposit. Structured deposits are not insured by the Singapore Deposit Insurance Corporation. Unlike traditional deposits, structured deposits have an investment element and returns may vary. You may wish to seek independent advice from a financial adviser before making a commitment to purchase this product. In the event that you choose not to seek independent advice from a financial adviser, you should carefully consider whether this product is suitable for you.
Where this material relates to dual currency investments, this clause applies:
The product is a dual currency investment. A dual currency investment product (“DCI”) is a derivative product or structured product with derivatives embedded in it. A DCI involves a currency option which confers on the deposit-taking institution the right to repay the principal sum at maturity in either the base or alternate currency. Part or all of the interest earned on this investment represents the premium on this option.
By purchasing this DCI, you are giving the issuer of this product the right to repay you at a future date in an alternate currency that is different from the currency in which your initial investment was made, regardless of whether you wish to be repaid in this currency at that time. DCIs are subject to foreign exchange fluctuations which may affect the return of your investment. Exchange controls may also be applicable to the currencies your investment is linked to. You may incur a loss on your principal sum in comparison with the base amount initially invested. You may wish to seek advice from a financial adviser before making a commitment to purchase this product. In the event that you choose not to seek advice from a financial adviser, you should carefully consider whether this product is suitable for you.
This document has not been delivered for registration to the Registrar of Companies in Hong Kong and its contents have not been reviewed by any regulatory authority in Hong Kong. Accordingly: (i) the shares/notes may not be offered or sold in Hong Kong by means of any document other than to persons who are "Professional Investors" within the meaning of the Securities and Futures Ordinance (Cap. 571) of Hong Kong and the Securities and Futures (Professional Investor) Rules made thereunder or in other circumstances which do not result in the document being a "prospectus" within the meaning of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) of Hong Kong or which do not constitute an offer to the public within the meaning of the Companies (Winding Up and Miscellaneous Provisions) Ordinance; and (ii) no person may issue any invitation, advertisement or other document relating to the shares/notes whether in Hong Kong or elsewhere, which is directed at, or the contents of which are likely to be accessed or read by, the public in Hong Kong (except if permitted to do so under the securities laws of Hong Kong) other than with respect to the shares/notes which are or are intended to be disposed of only to persons outside Hong Kong or only to "Professional Investors" within the meaning of the Securities and Futures Ordinance and the Securities and Futures (Professional Investor) Rules made thereunder.
Where this material relates to a Complex Product, this clause applies:
Warning Statement and Information about Complex Product
(Applicable to accounts managed by Hong Kong Relationship Manager)