As part of this news service's continuing examination of the ESG agenda, we talk to HSBC Private Banking about its approach.

This news service has been writing recently about environmental, social and governance-themed approaches to managing money. It might be tempting to suppose that this discipline looks irrelevant in an age of lockdowns and massive disruption to economic activity caused by a virus. But not so fast, maybe? Lockdowns have big social effects, such as how different people are affected – some losing their jobs and their business, while others continue to work, although now hunched in front of a laptop at home rather than in an office. And the “G” of ESG is certainly in view, with AGMs held virtually, or shareholder voting done remotely rather than in packed rooms. And the virus has thrown up issues of accountability and transparency of companies and governments. 

ESG then, is very much a live topic. But we have read the hype and the party line about how ESG is good for the Earth, good for society and good for how we run our lives. What wealth managers want to know, of course, is the nitty gritty: What returns look like, what happens to volatility of returns and how easy is it to measure the supposed “Alpha” that ESG generates? There are concerns about “greenwashing” and inevitably, some scepticism about whether ESG investing can deliver, and make a real dent in the universe. 

To consider some of these ideas is HSBC Private Banking. This news service recently interviewed Sophie Haas, CFA, who is head of sustainable product offering at the firm. 

Introductory remarks:
The term “ESG” is now as familiar as any other in the financial sector. A lot of wealth and investment firms, as well as banks and insurers, use it when promoting investments, new products, etc. 

Regardless of what happens with the global markets and economy this year, the focus on more supposedly sustainable energy production, and for more open governance and accountability, will continue. In fact, some might see geopolitical/medical and related crises as making it more, not less, important to follow ESG approaches. 

We hear from the industry that there is a need, still, for several things to make ESG more credible and robust, such as high-quality, digestible data for the clients; more clarity about products and services; proof of real impact; avoidance of worries about “greenwashing”; clarity on whether there are capacity constraints with ESG that require funds/other to be capped to avoid diluting returns. Other questions relate to whether wealth advisors are sufficiently clued up about the space; does the wealth industry train and guide people well enough? And will ESG survive a bear market or further adverse economic developments? 

From your point of view, what is the best, most succinct description of what ESG is, and is this the one you show to clients? 
Sustainable investment aims to allocate capital to enable the economy to prosper with due regard to financial returns, the environment and society. ESG is the integration of environmental, social and governance factors in the investment decision-making process. We look at ESG from both a risk and an opportunity perspective. 

But we also take a step back and look at the whole spectrum of capital, from responsible to impact investments, depending on the level of financial returns and environmental or social impact the client is keen to make through their investment portfolio. Sustainable investing is everything between traditional finance and philanthropy. 

Are you seeing a change in whether clients/advisors are the first to initiate a conversation about ESG?
ESG integration has been gaining prominence for institutional investors ever since the launch of the PRI Principles back in 2006. In the past only the most sophisticated clients initiated the conversation on sustainable investing. Now, as we see more headlines about climate change, poor corporate behaviour and issues of labour rights in supply chains, most investors are aware of these matters and want to understand how their investments can make a difference.  

What was once a differentiating factor is increasingly becoming the norm and is expected by a growing number of investors. 

As far as the ESG acronym is concerned, where do you see the most potential for interest: environmentalism, society, or governance? 
In the past we have seen more interest for environmental issues. The E of ESG is easier to understand and measure and has been more prominent in the media than the S and the G. Social aspects were perhaps harder to define or grasp for investors and their materiality not as well understood. 

However, with COVID-19, there will undoubtedly be an increasing focus on the social aspects. We have seen some good corporate behaviour emerge, with many employers offering health and job protection to employees, while others have behaved rather disappointingly in the eyes of many, furloughing their employees when some had the cash reserves to keep them on.   

In our view, ESG integration is the simple idea that companies which succeed long term, and hence deliver shareholder returns, are those which create value for all stakeholders - employees, customers, suppliers, the environment and wider society. (1)

Going forward, as an investor, we need to put more of an emphasis on social issues. For instance, are workers’ rights being respected? Is the lack of health benefits, paid holidays and sick leave putting employees in harm’s way? What policies should companies have to protect their workers in this challenging environment? Investors need to demand more from companies on social issues because consumers will also be asking themselves these questions and behave accordingly. It makes sense from a long-term return perspective and a societal well-being perspective. It seems as though COVID-19 is increasing the focus on the social aspect of the ESG equation. 

How much choice do you see clients having in being able to carry out their ESG ideas in various asset classes (stocks, bonds, real estate, infrastructure, private equity, hedge funds, other)? Are you seeing investor preferences skewing in one direction or another?
ESG integration into equity and fixed income by asset managers and asset owners is now well established. ESG is also looked at when it comes to alternative asset classes, with PRI setting new standards for private equity and hedge funds. Disclosure and reporting are far from standardised in alternative asset classes and remain voluntary, making it hard to compare one private equity fund manager with another for instance. 

What is your view of criticisms that too much ESG investing is tilted towards large cap equities because publicly quoted firms disclose more data and are easier to analyse? What are the drawbacks to that for investors, perhaps notably younger investors coming in, and how do you see it evolving?
On one hand, large cap companies do have more resources to put towards ESG disclosure and transparency. On the other, this means they are under more scrutiny in the public eye and under greater pressure from activist shareholders to make a change. 

Younger investors like our NextGen clients expect more from their investments than just generating financial returns. They want to do something meaningful with their investments, they understand that their investments can shape the society and environment we are all living in. We have seen a lot of reports of students lobbying their universities to divest their endowments from fossil fuels, for example. We need to offer investment solutions for their personal wealth that reflect their sense of purpose in a meaningful way, not in a cosmetic way. 
 

With more firms going private, what tools exist to analyse such firms from an ESG point of view? And from your vantage point, what can public markets learn from private markets on how to screen companies’ ESG practices? 
Sustainability and ESG integration rely on disclosure and transparency, which are more easily achieved in publically listed companies than in private ones. 

We already see this as being a challenge when integrating ESG into fixed income. Some private companies issuing debt are less transparent than listed ones, often because they are simply not required to do so. 

For private markets, I would focus rather on impact than ESG integration. Private markets have more flexibility to have impact targets as part of what investors expect from them. Additionally, they require new capital. Different objectives can be set more easily beyond maximising shareholder returns. 

MiFID II and other regulations have, so industry figures say, squeezed available sell-side research and there is not yet enough new research to fill the gaps. Does this research squeeze create an issue for executing ESG strategies consistently? What can be done about this? 
Research from top ESG research houses can be expensive. Given the subjectivity of the materiality of some elements of ESG analysis and different methodologies, it is also important to source that information from several providers to get a balanced perspective. 

We have seen a lot of consolidation of ESG research providers in the past few years. We hope this will make ESG data more consistent, widely available and affordable.

Do you see the discipline of behavioural finance, which seeks to understand how human habits influence investment, as being useful in thinking about ESG, such as how people can allow biases to influence their views of certain business sectors and countries?
Sustainable investing is somewhat subjective because there are as many clients as there are sustainability preferences and biases. This is particularly true regarding negative screening and ethical investing. While some clients want to exclude alcohol or tobacco, others prefer to omit fossil fuels or nuclear energy. These preferences have nothing to do with optimising efficiency by maximising their risk/return profile.

To some extent, sustainable investing is about integrating your values into your investment decisions so yes, human behaviour does play a large part in sustainable investing. 

Some firms and organisations make a big play of ESG; is enough being done to educate advisors, such as those at the graduate and post-graduate level? Can you cite any examples of people/organisations taking a lead on this?
ESG integration and sustainable investing must be more than a marketing exercise to avoid any greenwashing. We also need to ensure that we all speak the same language when there are various interpretations of the same terminology. Also, there is no regulatory harmonisation of definitions yet, besides the limited green EU taxonomy. 

For that we need more education and awareness of what sustainable investing truly means, both at a university-level and for established finance professionals. 

A great example of this is the CFA UK society launching the Certificate in ESG investing. This helps to ensure that practitioners have a minimum level of knowledge and a consistent understanding. 

There is currently a lot of volatility and fear in markets – how can ESG help frame investment and poise through such a period over the medium term?
At HSBC Private Bank, we believe that ESG will not only survive the bear market, but it will thrive even more so once we recover from it. In fact, it is more resilient than the rest of the market. Today’s market shows that too many actors fail to price in environmental and social externalities, which can lead to careless corporate behaviour towards stakeholders. 

COVID-19 has brought disruptions to communities and societies around the world and has highlighted how the most vulnerable are being treated. This crisis will hopefully put our wellbeing and the environment front and centre of our economic system and ESG integration is the most useful tool for investors to achieve that. 

Sustainable investing and ESG integration is all about minimising Environmental, Social and Governance risks and taking advantage of ESG opportunities while having a longer-term investment horizon. Therefore, we strongly believe that ESG will not only be resilient in the current market environment, it will also become more prevalent. 

If there is one final point that you would like to make about the ESG trend, what is it?
Some asset managers, financial advisors or data providers talk about ESG as the latest buzzword. What is important is to understand how they integrate it and what steps they are taking to implement it. ESG is not just a fad but a long-lasting change in how we invest, with huge benefits for all. 

References: 

1, Adapted from a quote from HSBC Global Research, ESG matters: Climate and ESG outperforming during COVID-19, 25 March 2020.