ESG in Practice series

How have sustainable securities performed in the equity market correction at the beginning of the year?

It is a mixed picture. At Pictet, ESG funds represent a fairly broad range of asset classes (equities, bonds, money market) and investment strategies. From the beginning of the year, the behaviour of equities has not been great when compared with traditional indices. However, sustainable investment has a long-term perspective and has performed very favourably over the past five years.

What lessons can you draw from this volatility?

The volatility of recent months has not called the fundamentals of sustainable investing into question. The decarbonisation of the economy, the energy transition or the growing need for drinking water do not depend on central banks’ monetary policy but on long-term trends. The case for investing in them is not undermined by short-term volatility. I would go as far as to say that ESG funds, which focus on better assessing, understanding and leveraging more robust corporate governance, should benefit from difficult market phases.

Why do you say that?

When money flows, there is no pressure to make the difficult choice between using cash flow for investment projects or for share buybacks. Therefore, the difference between long-term and short-term focused companies is not necessarily obvious. However, under tighter credit conditions, real differences in performance may appear in favour of companies that have favoured long-term investments over short-term savings.You have launched a fund investing in family-owned companies.

Does their governance tend to be different to others?

Leading ESG rating agencies use monolithic analysis criteria that tend to favour the corporate governance model of companies with diluted capital. These choices lead to discrimination against family businesses, which we define as those where the founders hold at least one third of the capital or voting rights. This becomes apparent when it comes to the independence of the Board of Directors, where the minimum threshold of 50% of independent directors can legitimately be questioned. We estimate that 10% of the market has a strong family anchorage, and have published a study demonstrating the inadequacy of agency analysis. We believe that governance analysis should adapt to the ownership structure and actual situation of companies rather than adhering to fixed models.

Do the best performing companies favour the interests of shareholders or employees or customers? 

Aren't we raising this topic again as we emerge from the pandemic and the so-called "great resignation" takes place?I agree with your observation. In this post-Covid period, millions of US workers are resigning for a number of reasons including quality of life and there is a real risk that the skilled workforce will become more scarce and expensive. In companies’ profit & loss accounts, employees are a source of costs and liabilities through wages, salaries and pension contributions.. But paradoxically, corporate culture and staff motivation around a common project do not appear as assets on the balance sheet. On this point, accounting does not help us.

We have therefore included additional criteria in our ESG analysis of companies. For example, we know that employee turnover varies across economic cycles and business areas, and we seek to avoid companies where it is unusually high. Companies with an employee turnover over 15% are renewing their human capital every six years. This results in a hidden but very significant cost.The ‘shareholder’ model, focusing on the interests of the shareholder, is flawed. The company of tomorrow must consider employees, customers, the environment and civil society. ESG analysis seeks to include these complementary aspects.

What have been the main steps in ESG management at Pictet?

Pictet’s roots in ESG management go back more than 20 years with funds investing in water and sustainable European equities. This range has continued to expand into other asset classes. The diversification of the offering has accelerated in recent years with the European SFDR classification. A year ago, we had converted 50% of our funds to meet the standards in Article 8 and Article 9. We are now at 75%.

What are your priorities for the coming months?

We are committed to the Net Zero Asset Management and Science Based Target initiatives, which mean that our own investments and activities will be carbon neutral by 2050. We already have a structural bias in favour of the green economy and we plan to publish an action plan in this respect with interim targets of 5 and 10 years by the end of the year.If we want to be strict in respect of the environment and only include companies that do not harm the climate, only 5% of companies are eligible. 

Is this a purist's dream?

The green economy is still largely in the minority. Only 5 to 10% of issuers respond. It's still not much, but that's how it is. But the green economy is growing much faster than the global economy, which is good news for investors and for the environment.

So, what do we do with the other 90%? Refuse to invest?

Investor demand is very broad and heterogeneous, both in Switzerland and elsewhere. To meet this demand, we have developed investment strategies that favour securities that are not the best rated but have significant potential for ESG improvement. We engage with them actively to encourage them to transform. A good example is the German company RWE. Five years ago it was the nemesis of all ESG investors because it was Europe’s largest CO2 emitter.

The company made a 180-degree turnaround by committing to shut down all of its coal-fired power plants in the next 10 to 15 years and accelerating the development of wind power with over €50 billion of investment in green energy over the next ten years. The difficulty is knowing when to invest responsibly in this type of company. Should you wait until it is completely green? Or when the Board of Directors announces a strategic shift? If we wait until it is 100% green, we may have lost the opportunity to participate in this virtuous change dynamic.

What are the pitfalls of green taxonomy?

First of all, there are pitfalls in the implementation of the CSRD (Corporate Sustainability Reporting Directive) and, from 2023, the publication by companies of the share of their turnover achieved in eligible activities. As investors, we are currently left to make our own evaluations. We were the first to have our clean energy strategy audited for alignment with the green taxonomy.

This work is laborious, but indispensable, as we are bound by obligations of transparency. This approximation phase will take another 12 to 24 months. And let’s not forget that CSRD only applies to European companies, which account for less than half of global equity funds. Therefore, the other half of the stock market will not be forced to disclose numbers, unless foreign investors, for example, request it to communicate figures for their funds marketed in Europe.