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The evolution of ESG
and responsible investing

Environmental, social and governance principles gaining traction

Investing using environmental, social and governance (ESG) principles is garnering much interest from advisors and investors, but there is still some confusion about what it actually entails. To learn more, we recently spoke with Melanie Adams, Vice President and Head of Corporate Governance and Responsible Investment, and Derek Butcher, Senior ESG Analyst at RBC Global Asset Management (RBC GAM).

Melanie Adams

MELANIE ADAMS

Derek Butcher

DEREK BUTCHER

Let’s begin by defining ESG. How do you distinguish it from other forms of responsible investing?

Adams: Responsible investment, or RI, is an umbrella term used to describe three key investment strategies. The first is socially responsible investing, or SRI, which involves either positive or negative screening to select companies or investments based on a predefined set of values. For example, you might screen out tobacco companies, or alcohol- or fossil fuel-related investments. The second is impact investing, where you’re investing with the intention of creating a positive environmental or social impact, along with a positive financial return. The third is ESG integration, which involves the analysis of ESG factors as part of the investment process. An investment team analyzes ESG factors to understand if a company is appropriately addressing ESG risks and opportunities, and whether or not they are appropriately reflected in security prices.

Responsible Investment (RI)

Socially responsible investing
The application of positive or negative screens to include or exclude companies from the investment universe based on a defined set of values.

Impact investing
The investment in securities of issuers that intend to generate a measurable positive social or environmental impact.

ESG integration
The systematic integration of ESG factors into investment processes.

There’s an incredible opportunity for advisors to fill the (responsible investment) knowledge gap. To that end, I’ve observed an increasing number of advisors seeking responsible investment accreditations, with the goal of enhancing their knowledge of ESG and RI so they can meet the demands of their clients.

DEREK BUTCHER
Senior ESG Analyst of Corporate Governance and Responsible Investment at RBC GAM

Could you describe RBC GAM’s specialized approach to ESG? What makes it different?

Adams: At RBC GAM, all of our investment teams integrate ESG into their investment management processes. We believe that ESG integration has the potential to enhance the long-term risk-adjusted returns of our portfolios or strategies. Each team integrates ESG factors in a manner that complements their process and investment style. This means that not every team is going to have the same process. For example, while our Emerging Markets Equity team pays particularly close attention to supply chain risk, among other factors, our corporate fixed income teams may focus on how ESG factors can impact a company’s ability to repay debt as part of their analyses. We have a fiduciary duty to our clients as stewards of their assets, and ESG integration helps us fulfill that duty.

As RI and ESG continue to evolve, do you find that investors are becoming increasingly familiar with and seeking these solutions?

Butcher: Yes, and I think this points to a business opportunity for advisors as well. A 2018 survey from the Responsible Investment Association in Canada showed that 77% of respondents, who were either current or potential investors, were “very interested” or “somewhat interested” in RI. However, that same study showed that 73% of respondents said they know little or nothing about RI1. There’s an incredible opportunity for advisors to fill the knowledge gap. To that end, I’ve observed an increasing number of advisors seeking responsible investment accreditations, with the goal of enhancing their knowledge of ESG and RI so they can meet the demands of their clients.

Can ESG factors help mitigate risk?

Source: 2019 Responsible Investment Survey,RBC Global Asset Management.

How do you believe ESG integrated portfolios are likely to perform relative to non-ESG integrated portfolios?

What are the benefits to investors/ clients of investing in RI and ESG-integrated strategies?

Adams: One of the primary benefits is the potential for enhanced long-term risk-adjusted returns. Several ESG integration studies, such as those by Morningstar and ETF.com, have shown that looking at ESG factors as part of the investment process can result in decreased volatility2. From a historical perspective, back in the 1970s the value of a company was made up of up to 20% non-financial factors, including ESG factors such as employee and customer satisfaction. Today it’s more than 80%.

Butcher: Another benefit, which is one of the core components of RI and ESG integration as a whole, is stewardship. We exercise that through proxy voting and engaging with company management teams and boards directly on ESG issues. We take a very thoughtful approach to proxy voting. We carefully review company performance and corporate governance practices, all to ensure an informed vote. Along with engagement, this level of stewardship helps drive greater overall disclosure to shareholders and encourages better practices that we believe will contribute to better long-term risk-adjusted returns.

PORTFOLIO MANAGER PERSPECTIVE
BRYAN MASCOE
VP & Portfolio Manager, Phillips, Hager & North Investment Management

The ESG engagement issues facing fixed income managers can be substantially different than those of equity managers, as fixed income managers do not generally have the power of proxy voting. However, Mascoe points out that the necessity of refinancing provides the opportunity for fixed income managers to address ESG factors with issuers.

JEREMY RICHARDSON
Senior Portfolio Manager, RBC Global Asset Management (UK) Ltd.

One of the challenges of engaging corporations in ESG issues globally is the differences in corporate cultures that impact governance and companies’ approaches to RI. And some of these are fairly nuanced, Richardson explains. Europe has a reputation of being generally ahead on ESG issues than other markets, such as North America. He attributes some of that to evolving views on what contributes to shareholder value.

When companies focus on returns above all else, especially in the short term, it can lead to a very limited definition of what contributes to shareholder success. However, with the wider acceptance of ESG principles, this very narrow definition is being challenged, and we’re seeing an increasing move towards a more holistic view of long-term shareholder value.

JEREMY RICHARDSON

There seems to be some perception that RI and ESG investing could negatively impact investment returns. How prevalent are these beliefs?

Butcher: That perception is definitely out there, but it appears to be receding. If you look at RBC GAM’s 2019 Responsible Investment Survey, we saw that a majority of respondents (58%) believed that incorporating ESG into their investment processes can help mitigate risk. That same research also showed that approximately 82% of respondents believe that portfolios incorporating ESG will perform as well as or better than portfolios that don’t3. A key part of changing perceptions is challenging the assumption that RI means exclusion, or making a portfolio less efficient, by limiting your investment universe. ESG integration doesn’t involve the outright exclusion of any securities. Instead, it’s deliberately considering material ESG factors in the investment process.

What additional trends are you observing with respect to RI and ESG investing in Canada?

Adams: With respect to specific ESG factors, investors seem to be increasingly concerned with the risks related to climate change, whether it’s the physical risks, due to flooding, for example, or transition risks, which result from companies adjusting to policy or regulatory changes put in place to meet global warming targets. Investors appear increasingly focused on cybersecurity and anti-corruption issues as well.

PORTFOLIO MANAGER PERSPECTIVE
SARAH NEILSON
Portfolio Manager, North American Equities, RBC Global Asset Management

As a specialist in the Canadian Energy sector, Neilson is well aware of the complex nature of tackling ESG issues in the country’s oil and natural gas industries and maintaining a focus on environmental concerns. Through her engagement efforts, she reports that major players in these industries are well aware of the new dynamics of global markets. Energy commodities continue to be in high demand worldwide amid calls for reductions in emissions, meaning that companies need to be innovative in reducing their carbon footprint and intensity.

Both on an individual and industry-wide basis, Canadian companies are investing their own dollars in research and development to engineer new clean and green technologies to drive their costs lower, and keep them competitive in an environment of global targets for greenhouse gas emissions. This is something I’m witnessing across the industry, which I’ve been covering for almost a decade. We’re seeing more information sharing across companies within Canada than we’ve ever seen before, all in a drive towards that goal of reducing our footprint, emissions intensity and costs to maintain global competitiveness.

SARAH NEILSON

Which one do you believe is more impactful – divestment or engagement?

Butcher: First of all, it’s important to note that for investors or clients who wish to divest from particular sectors or lines of business, there are numerous compelling socially responsible investing solutions available to meet those needs. The opportunity is there for an advisor to play a key role in finding the right solution for them. For RBC GAM as an asset manager, we generally prefer engagement over divestment. By engaging with companies as an owner or lender, we’re able to express our views and concerns, and can push boards and management to improve on material ESG factors.

How would you describe your engagement on the issue of gender diversity on corporate boards and senior leadership in companies, and the degree of progress made so far?

Butcher: In 2019, the Canadian Securities Administrators indicated that only 17% of board seats were held by women4. There is clearly still more work that needs to be done in this space. At RBC GAM, we’re members of the 30% Club Investor Group, a Canadian and global network of investment professionals and companies who advocate for greater representation of women on corporate boards and senior management. One of the group’s goals is to see a minimum of 30% women on boards and executive management teams of S&P/TSX Composite Index companies by 2022. RBC GAM is committed to advocating for greater gender diversity on boards through proxy voting and engagement. In particular, in our custom proxy voting guidelines we have been increasing our requirement for women on boards, and now require at least two women on the boards of our investee companies.

For more information about ESG investing, visit www.rbcgam.com/ri.

References:
1. 2018 Canadian Responsible Investment Trends Report, Responsible Investment Association, October 2018.
2. Ryan Vlastelica, “‘Sustainable’ funds outperformed the broad market in the recent correction,” MarketWatch, February 15, 2018; Lara Crigger, “The Year In ESG ETFs,” ETF.com, December 20, 2018.
3. 2019 Responsible Investment Survey, RBC Global Asset Management.
4. CSA Multilateral Staff Notice 58-311, Report on Fifth Staff Review of Disclosure Regarding Women on Boards and in Executive Officer Positions, Canadian Securities Administrators, October 2, 2019.

RBC Global Asset Management (RBC GAM) is the asset management division of Royal Bank of Canada (RBC) which includes RBC Global Asset Management Inc. (including Phillips, Hager & North Investment Management), RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, RBC Global Asset Management (Asia) Limited, and BlueBay Asset Management LLP, which are separate, but affiliated subsidiaries of RBC.

RBC Global Asset Management