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The Institutional Investor’s Guide to ESG INVESTING P&I Custom Content in partnership with

CONTENTS

This Guide is a resource for best practices and current trends in environmental, social and governance (ESG) investing, which has gained momentum as asset owners have embraced responsible investing and sustainable objectives. It’s an evolving field that continues to see advances across asset classes, data availability, benchmarking and engagement.

Each section offers guidance on the approaches that investors are taking to engage with asset managers, corporates, issuers and wider industry groups in order to promote and expand the use of ESG factors and sustainable approaches within investment portfolios.

The Guide has been updated to reflect the latest developments in sustainability strategies and the top ESG themes for 2024.

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I

DEFINING ESG INVESTING

ESG investing has gained momentum among institutional investors, and it has expanded to deliver a broad range of portfolio objectives across asset classes and strategies. Most asset owners today consider sustainable factors or pursue ESG themes, and many have established sustainability goals. Ongoing dialogue among investors, corporations, sovereigns and regulators is now focused on practical implementation across the investment universe.

This Institutional Investor’s Guide to ESG Investing, sponsored by Pictet Asset Management (Pictet AM), provides current insights and best practices as well as a road map for how to implement, monitor and manage a sustainable portfolio. It covers sustainability by asset class, data and disclosure issues, benchmarking, regulation, industry initiatives and more.

As new opportunities continue to emerge and methodologies develop, the underlying strategic rationale across ESG investing reflects both long-term return potential from sustainable opportunities and risk mitigation.

“Historically, [ESG investing] meant managing risk around environment, social and corporate governance factors in a formalized way,” said Robert Simpson, senior portfolio manager of emerging markets fixed income at Pictet AM. That has progressed to considering investments not just with a risk perspective, but also with considerations of the positive and negative impacts of those investments on the environment and society. “We’ve moved from using ESG as an analytical input to sustainability as an investment output,” he said.

We’ve moved from using ESG as an analytical input to sustainability as an investment output.
Robert Simpson
Senior Portfolio Manager of Emerging Markets Fixed Income, Pictet AM

Aligning investment portfolios with sustainable outcomes also brings them in line with the long-term interests of all stakeholders, including asset owners, their managers and the companies and other entities that they finance. “Investing with a sustainable approach aims to deliver, over the long-run, better outcomes for all stakeholders and delivers a better return profile,” Simpson said.

Two specific themes have moved to the forefront of sustainable investing: clean energy and biodiversity. The transition to clean energy sources, away from fossil fuels, has become a distinct subsector offering a more comprehensive range of investment strategies. And investor recognition that the health of ecosystems is a key factor of sustainability has deepened the focus on biodiversity.

Examples of ESG Factors

As investor commitment to ESG awareness and sustainability grows, there are ongoing concerns — and persistent challenges — around greater accountability, regulatory scrutiny, standardized data and corporate disclosure. Addressing accountability requires informed perspective and experience in ESG investing by both allocators and asset managers. Progress on data transparency and standardization is continuing apace, as regulators, data providers and asset managers remain committed to strengthening sustainability factors across investment portfolios.

Global ESG assets are on track to exceed $53 trillion by 2025, representing more than a third of the $140.5 trillion in the world’s projected total AUM, according to Bloomberg Intelligence.

 
Clean energy transition strategies are based on long-term, secular trends. It’s an area where we expect to capture opportunities from companies that we believe will grow, based on increasing demand.
Jennifer Boscardin-Ching
Client Portfolio Manager of Environmental Thematic Investing, Pictet AM

Spectrum of ESG Approaches

Asset owners can utilize several different approaches to ESG investing. Broadly, Pictet AM defines these as three types of strategies: ESG integrated, ESG focused and positive impact, based on the European Union’s Sustainable Finance Disclosures Regulation (SFDR).

ESG Integrated: In an integrated approach, the asset manager takes ESG factors into account in the analysis of a stock or bond to enhance a portfolio’s risk-return profile. Those considerations can have a material impact on the company’s performance and are weighted alongside other financial factors that inform an investment decision. Portfolios may invest in securities with high sustainability risks. However, with this approach, the goal is not to promote an environmental or social outcome. ESG integrated is equivalent to an article 6 SFDR.*

ESG Focused: In a focused approach, investors promote environmental and/or social characteristics. Their investments may also be considered sustainable if the companies in which the investments are made follow good governance practices. ESG focused is equivalent to an article 8 SFDR.*

Positive Impact: With an impact strategy, the investments promote economic activities that are environmentally and/or socially sustainable in companies that must also have good governance practices. Investors often employ an impact approach through a thematic strategy that targets a specific challenge, such as clean water or clean energy. Positive impact is equivalent to an article 8 or 9 SFDR.*

*Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (SFDR).

Types of ESG Approaches
Responsible Strategies: The Full Spectrum charts
ESG integrated is equivalent to an article 6 SFDR and may invest in securities with high sustainability risks. ESG focused is equivalent to an article 8 SFDR. Positive impact is equivalent to an article 8 (with at least 51% of sustainable investments) or 9 SFDR. SFDR: Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector. Click here to find a glossary with the main terms.

Source: Pictet Asset Management, June 30, 2023.

Expanding Regulation

Government policy worldwide continues on a path toward mandating and regulating ESG disclosures. Many regulators require asset managers to identify and define their approaches and methodologies to sustainability in more specific terms. In response to the need for more specific metrics on sustainability, asset managers are investing in proprietary tools that, in turn, need more disclosure from issuers, creating more transparency in ESG metrics across the investing universe.

Across the globe, regulators are accelerating ESG policies and enacting legislation, with a particular focus on climate change and the need to support the transition to a net-zero emissions future. Supportive policies are serving as tailwinds for companies, technologies and industries that are integral to sustainability and the clean energy transition.

Recent legislation includes the U.S. Infrastructure Investment and Jobs Act, passed in late 2021, and the Inflation Reduction Act, passed in August 2022, both of which include key elements for the clean energy transition. In 2022, the European Commission (EC) proposed REPowerEU, a plan to increase Europe’s energy independence and encourage investment in renewable power, energy efficiency and overall decarbonization. Also, in early 2023, the EC released the Green Deal Industrial Plan, which included the Net-Zero Industry Act that supports investment in low-carbon technologies, among other elements.

China has also made a series of public announcements about its strategic direction on sustainability within its broader economic planning. In 2021, China unveiled its 2030 carbon action plan, which phases down coal consumption, installs renewable energy capacity, implements green building standards and provides significant support to help make its industrial sector more resource efficient. In October 2022, China’s 20th Party Congress clearly emphasized a transition to green development, pollution prevention and control, ecosystem preservation and achieving carbon neutrality.

In December 2022, delegates from around the world attended the 15th Conference of Parties to the U.N. Convention on Biological Diversity and adopted the Kunming-Montreal Global Biodiversity Framework. Similar to the Paris Agreement on climate change, the framework consists of global targets to be achieved by 2030 that safeguard biodiversity.

Supporting Investments

“We’re seeing a green capex investment wave,” said Jennifer Boscardin-Ching, client portfolio manager of environmental thematic investing at Pictet AM. “These regulatory policies are translating into higher demand for sustainable products and services.” In Europe and the U.S., in particular, ESG legislation has powered strong tailwinds for companies to comply on processes and reporting. “The scale of investment in this space is quite remarkable,” she said, noting that Pictet AM sees several areas where ESG-related fundamentals have improved.

In one example, following the passage of the two U.S. bills, an electronics components company that Pictet invests in has seen increased growth opportunities through the approximately $800 billion in U.S. investments announced last year across clean energy initiatives like electric vehicle manufacturing, semiconductor fabrication and renewable energy projects, Boscardin-Ching said. Of the $800 billion, only 20% to 25% of industry projects have actually broken ground, meaning 75% of the capital committed is still in the pipeline.

Global Initiatives on ESG and Responsible Investing

Global challenges, such as climate change and social inequality, are too big for a single investor or a single country to address significantly without widespread support. Therefore, a number of global and regional entities and initiatives have helped set sustainability standards and guidelines that continue to drive progress. Here are some early proponents:

The Principles for Responsible Investment (PRI)
The United Nations-supported PRI, one of the earliest ESG initiatives, launched in 2006 to establish a framework for responsible investing via ESG disclosure and metrics. It provides a standardized approach to ESG integration within the investment process and within an asset manager’s active ownership practices, including engagement and proxy voting.

Pictet AM is one of more than 5,300 asset owners and asset managers, as of January 2024, that are PRI signatories. The signatories have moved to integrate the PRI principles into their investment process and broader ESG stewardship efforts. As part of their commitment, asset managers work to promote ESG principles across the investment industry and report on their own progress in implementing the principles.

These regulatory policies are translating into higher demand for sustainable products and services.
Jennifer Boscardin-Ching
Client Portfolio Manager of Environmental Thematic Investing, Pictet AM

UN Sustainable Development Goals (SDGs)
SDGs are a set of global social, environmental and economic goals targeted for achievement by 2023. They were agreed upon by the United Nations’ member countries in 2015. Some SDGs are investible, such as clean water and climate action. Others are more the purview of governments, such as establishing peace and strong institutions.

Institutional investors can use SDGs to determine how companies are exposed to factors that affect these goals and to help create an impact investment strategy. Asset managers often align with the SDGs through focused thematic strategies.

In one notable development, Pictet AM’s positive change strategy, co-led by senior portfolio managers Evgenia Molotova and Yuko Takano, focuses on companies that optimize the U.N.’s goals by focusing on environmental factors, social factors and boosting economic potential.

Watch: Positive Change — Investing in the Transition to a Sustainable Future

Sustainable Development Goals

Sustainable Finance Disclosures Regulation
The European Union’s Sustainable Finance Disclosures Regulation (SFDR Level 1) was introduced in 2019 and came into effect in March 2021. The set of rules aims to make the sustainability profile of investment funds more transparent and comparable. Ultimately, the rules are designed to give asset owners more clarity about a strategy’s sustainability characteristics and to prevent “greenwashing,” a term used to describe how some firms make misleading claims about the ESG credentials of their strategies.

In January 2023, SFDR Level 2, which includes more detailed disclosures based on technical standards, was activated. This level provides specific guidance and templates on exactly how and where disclosures should be made, including principal adverse impact (PAI) reporting, pre-contractual templates or periodic reports.

 

Task Force for Climate-Related Financial Disclosures (TCFD)
TCFD was created by the Financial Stability Board, with the support of some G20 member countries, to develop and promote more effective climate-related financial disclosures from issuers. The initiative is important because ESG investors depend on the quality of issuer disclosures and their standardization in order to determine how companies are transitioning to a net-zero economy.

Taskforce on Nature-Related Financial Disclosures (TNFD)
This private-sector initiative, launched in June 2021, has created a global framework to help organizations manage and disclose their nature-related dependencies, impacts, risks and opportunities. Its guidance and recommendations enable organizations to integrate nature into business and financial decision making and to support a shift in global financial flows toward nature-positive outcomes.

Net Zero Asset Managers Initiative
The initiative is an international group of asset managers committed to supporting the goal of net-zero greenhouse gas emissions by 2050 or sooner, in line with global efforts to limit planet warming to 1.5 degrees Celsius. The initiative was launched in December 2020. As of December 4, 2023, there were more than 315 signatories — Pictet AM being one of them — representing a total of $59 trillion in assets under management.

Science Based Targets Initiative (SBTi)
This initiative defines and promotes private-sector best practices for emissions reductions and net-zero targets in line with climate science. Science-based targets show companies and financial institutions how much and how quickly they need to reduce their greenhouse gas emissions to prevent the worst effects of climate change. SBTi is a partnership among CDP Worldwide (Carbon Disclosure Project), the United Nations Global Compact, World Resources Institute and the World Wide Fund for Nature. Pictet Group, parent company of Pictet AM, is a member of SBTi.

Watch: Pictet’s Climate Action Plan —Renaud de Planta, Senior Managing Partner, Pictet Group

Key ESG themes today

Institutional investors are pursuing a range of ESG-related themes across their portfolios that aim to boost sustainability goals across key environmental and social issues. They include:
  • Climate change
  • Diversity, equity and inclusion
  • Clean energy transition
  • Water management
  • Waste management
  • Sustainable agriculture practices
  • Sustainable forestry
  • Biodiversity
  • Nutrition
  • Smart city (grid infrastructure)

Read: Costing the Earth: measuring corporations’ impact on biodiversity loss

Investment theme: Clean energy transition

As new technologies come online, it’s important to focus on quality businesses that are profitable, scalable and that generate free cash flow.
Jennifer Boscardin-Ching
Client Portfolio Manager of Environmental Thematic Investing, Pictet AM

The transition to clean energy sources and the shift away from fossil fuels remains a leading responsible investment theme. “Clean energy transition strategies are based on long-term, secular trends. It’s an area where we expect to capture opportunities from companies that we believe will grow, based on increasing demand,” said Boscardin-Ching.

Pictet AM takes a focused approach to its clean energy transition strategy by clearly defining the investible universe or the opportunity set available to investors. “There’s a common misperception that investing in climate mitigation and clean energy transition means only renewables and electric vehicles. But it’s important to realize that there’s a much more diversified range of sectors and industries,” she said. Pictet AM looks across the entire energy complex and value chain, taking in the totality of the clean energy transition process. That can include more traditional companies in the energy industry that have committed to goals related to the net-zero transition.

Read: Adding thematic equities to diversified portfolios

The shift away from fossil fuels and polluting power-generation sources entails replacing existing, no-longer-profitable oil, gas and coal facilities with new clean-power generation. “Here, many people think only about pure-play renewable companies, like solar or wind-turbine manufacturers,” said Boscardin-Ching. However, within a holistic view of transition, power utilities may also be attractive. “It’s now much cheaper to install renewable assets instead of running existing fossil-fuel assets even without legislative support. Clean energy transition is not only a niche of pure-play renewables companies anymore. Power utilities are joining the space,” she said.

Distribution infrastructure also offers opportunities, including demand to build or modernize the electric grid, power transmission lines and electric vehicle charging stations. “This enabling infrastructure is needed to accommodate a cleaner, more efficient and more dynamic energy system,” Boscardin-Ching said. “We take a holistic view of the critical enablers and what needs to change; the universe is broader than what people think.” In addition, the Enabling Technologies segment also includes the underlying elements, such as specialty semiconductors and battery components.

The demand side for energy-efficiency presents a broad array of opportunities too, such as energy-efficient buildings, lighting, appliances and climate control. Efficient manufacturing is a subsegment, which includes decarbonizing industrial operations and making them more resource efficient. Advanced simulation and predictive-maintenance software are rapidly growing, as are smart-mobility solutions.

Examples of Environmental Themes

In Pictet AM’s clean energy transition strategy, the firm works with a clearly defined opportunity set that’s focused on quality and profitability. “As new technologies come online, it’s important to focus on quality businesses that are profitable, scalable and that generate free cash flow,” said Boscardin-Ching.

Pictet AM prefers to invest in technologies that are currently available and are growing in industry usage, versus those on the leading edge. “The quality and profitability angle is very important in the clean energy space, because it’s possible for investors to invest in commoditized business models or technologies that may support clean energy but aren’t profitable and that have growing concerns,” she said.

Investment Theme: Biodiversity

Pictet AM addresses biodiversity as mitigating the risk of losing the abundance of species necessary for ecosystem health. From an investment perspective, a company’s biodiversity footprint can be a material financial factor.

In 2014, Pictet AM launched its global environmental opportunities strategy that incorporates the Stockholm Resilience Centre’s Planetary Boundaries (PB) framework. “We evaluate and select companies that have a footprint that is compatible with the safe operating space determined by the PB’s nine critical environmental dimensions, with biodiversity being one of them,” said Steve Freedman, head of research and sustainability, thematic equities, at Pictet AM.

The PB framework is a life-cycle assessment that measures the impacts of a company’s operations combined with those of its upstream and downstream processes. This includes its supply chain plus the impacts of its goods and services during and after use. “Through this process, we’ve extended our thinking on biodiversity by refining the approaches we take, and we’ve launched other portfolios within our environmental thematic strategies group,” Freedman said.

We’ve extended our thinking on biodiversity by refining the approaches we take, and we’ve launched other portfolios within our environmental thematic strategies group.
Steve Freedman
Head of Research and Sustainability, Thematic Equities, Pictet AM

While the asset management industry has only just begun to factor in biodiversity, “we’re in a phase where the data landscape is evolving quickly,” Freedman said. He pointed to a number of initiatives coming to fruition, primarily the Taskforce on Nature-Related Financial Disclosures, which encourages companies to be more transparent about the risks and effects of biodiversity loss and which is quickly becoming a market standard. “Over time, this will make it easier to use actual data, instead of the estimates available today, and to understand a company’s actual profile on biodiversity,” he said.

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SUSTAINABILITY ACROSS ASSET CLASSES

While asset owners can take a responsible investing approach and apply an ESG framework across their entire portfolio, there are unique considerations for different asset classes. Here are some key takeaways that an institutional investor needs to be aware of in equity and fixed income:

Equity

Sustainable approaches in equity investing are the most developed among all asset classes. Many institutional investors have applied, or are familiar with, methodologies such as negative or exclusionary screens and integration of sustainability factors in portfolios based on company-level ESG ratings or scores.

One of the biggest challenges of responsible investing is applying increasingly sophisticated data — which usually comes from disparate sources — in a way that informs an investment thesis for a specific issuer. As such, investors need to understand and be comfortable with their asset managers’ internal framework for scoring companies on ESG factors.

The ESG Scorecard
At Pictet AM, the scoring framework revolves around a proprietary ESG Scorecard that provides a focused view of the ESG risks and opportunities associated with an issuer, based on a curated set of the most material data points across four themes, or pillars.

  • Corporate governance: Considers factors such as board competence and independence, executive remuneration, audit and risk controls.
  • Products and services: Examines how the company is generating its revenue. For example, are its products or services addressing public health or environmental issues? Is the company offering “clean and safe” products and services?
  • Operational risks: Provides a gauge of a company’s operational issues, including the carbon intensity of its operations and whether it is exposed to extreme weather events or other climate risks. It also analyzes factors such as whether the company is managing the environmental and social impacts associated with its supply chain.
  • Controversies: Examines and includes any negative issues that a company has been involved with, such as bribery and corruption, market abuse or product recalls.
 
Four Pillars of the ESG Scorecard

The ESG Scorecard indicates areas of ESG concern with red flags, while areas seen as positive are indicated with green flags. Flags can stem from each individual data source and are summed up at both the pillar and Scorecard level. Individual or multiple companies can then be compared uniformly, within and across sectors and locations, to identify ESG leaders as well as laggards.

Sample of ESG Scorecard

Fixed Income
Many responsible investing considerations for fixed income are similar to those for equity. Asset owners can work with their fixed-income managers to establish criteria for integration. Asset owners also need to understand their managers’ scoring processes. For example, Pictet AM uses a proprietary framework, including principles established by its ESG Scorecard, to evaluate issuers of corporate debt.

The introduction of SFDR Level 2 in 2022 encouraged fixed-income managers to provide more clarity around ESG strategies and methodologies.

The important thing for emerging markets in particular is the sustainable environment, which goes far beyond climate to include human capital.
Robert Simpson
Senior Portfolio Manager of Emerging Markets Fixed Income, Pictet AM

Sovereign Issuers

Evaluating sustainability factors for sovereign debt adds a layer of complexity and a more robust evaluation process. There is not yet industry consensus on how best to rate ESG for a country, given the lack of common standards. Applying a blunt ESG score, based on absolute criteria, can create a bias toward wealthier economies while a poor score can reflect structural impediments within a country that may be working to improve its ESG profile.

“If you use ESG as a scoring threshold for sovereign bonds, it can take capital away from where it’s needed most. To invest with a sustainable lens, you need issuer-level metrics and reporting around the sustainability areas that they are targeting to achieve a positive investment outcome,” said Simpson. However, data consistency is still lacking, and “the next stage is to develop outcome-related data in a clear and methodical fashion,” he said.

Read: Why EM bond investors can no longer ignore ESG

Emerging Markets
Pictet AM uses a multi-layered approach to sustainable investing in emerging market fixed income. It starts with an intention toward integration by applying ESG scoring methodologies. However, it will move to apply exclusion as an absolute last resort, said Simpson. “We seek to engage with those companies, and especially countries, that have low [ESG] scores to understand the strategy around bridging the gap, improving the score and taking a forward-looking approach to how the metrics can evolve,” he explained.

The second layer is Pictet AM’s responsible investment framework, which governs the types of sovereign and corporate investments the firm is willing to make. The final layer is to target sustainable development at the country level. “The important thing for emerging markets in particular is the sustainable environment, which goes far beyond climate to include human capital. For example, a focus on education and health care better supports growth that is less carbon intensive,” Simpson said.

Green Bonds, Sustainability Bonds and Social Bonds
Green bonds — debt issues raised to finance specific projects related to the environment, a majority of which address climate change — are an area of sustainable fixed income that has seen robust growth. Sustainability bonds and social bonds are similar to green bonds, but they support a greater cross-section of projects, including education, sanitation and clean transportation. When considering these types of bonds, investors need to be wary of greenwashing, as there have been many instances of green, sustainable and social bond proceeds being used for purposes other than their stated environmental objective, such as refinancing existing debt.

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WORKING WITH YOUR ASSET MANAGER

Sustainable investing has become more widely accepted, and most global asset managers embrace ESG factors in their decision-making process. But the approaches, methodologies and level of commitment among them varies considerably. Asset owners need to do their due diligence to determine how — and how well — responsible principles that incorporate ESG factors and metrics are embedded into an asset manager’s investment process and the firm’s culture.

Is sustainability supported from the top?
When sustainability and responsible investing is encouraged by the chief executive officer and other C-suite executives at an asset management firm, it can have a cascading effect through the company’s culture. The commitment from top executives is best demonstrated not just by what they say about ESG, but also by what they do. For example, Laurent Ramsey, managing partner of Pictet Group, shares his views on investing in the transition to a sustainable future.

Watch: Laurent Ramsey, Managing Partner, Pictet Group

Does the asset manager engage with the scientific community on climate and other environmental issues?
The body of knowledge surrounding climate science continues to evolve. As such, asset managers dedicated to addressing environmental issues must step outside the realm of finance and collaborate with the scientific community to inform investment analysis.

At Pictet AM, scientific collaboration takes many forms. The firm produces research and thought leadership on environmental issues in collaboration with several universities. University professors who are leaders in climate science and ecology are also on the firm’s thematic strategy advisory boards.

Examples of Scientific Partnership:
Pictet AM has partnered with the Stockholm Resilience Centre (SRC), a renowned international research organization behind the Planetary Boundaries (PB). The PB framework, developed at the SRC in collaboration with scientists around the world, identifies the nine most critical environmental dimensions — including carbon emissions, freshwater use, land use and biodiversity — that are essential to maintaining a stable biosphere.

Pictet AM uses the PB model to help define its investible universe and determine which firms develop products and services that can make a real difference in reversing environmental degradation.

Pictet AM sponsors Finbio (Finance to Revive Biodiversity), a four-year initiative of the Swedish Foundation for Strategic Environmental Research (MISTRA) led by the SRC and a number of universities, to conduct research into the interaction between finance and biodiversity. Pictet AM provides private-sector feedback on research projects and how they might ultimately be implemented in the financial industry.

Planetary Boundaries

Does an ESG-specific team work alongside the investment team?
While portfolio managers and analysts play a critical role in considering ESG factors in the investment process, some asset managers also maintain an additional resource: a dedicated ESG-specific team that works alongside the investment teams.

At Pictet AM, the ESG-specific team, headed by Eric Borremans, coordinates implementation of their responsible-investment policy, including ESG integration in investment processes, risk management, training on ESG-specific issues and reporting tools. In addition, it keeps the investment team up to date on how ESG third-party data is evolving, and it coordinates corporate and sovereign engagement across strategies with the same issuer so that the firm can put its full heft behind an initiative.

Watch: Eric Borremans, Head of ESG, Pictet AM

How robust is the analysis of companies based on ESG criteria?
With ESG ratings and data now widely available, asset managers can often find outside sources to inform their ESG analysis on an issuer. However, asset managers who are dedicated to ESG and responsible investing tend to have a robust proprietary process that connects data from multiple sources and that weighs relative data points appropriately for each holding.

Pictet AM’s proprietary ESG Scorecard distills all the disparate data, sourced both externally and internally, into a comprehensive view of an issuer’s ESG risks and opportunities.

We seek to engage with those companies, and especially countries, that have low [ESG] scores to understand the strategy around bridging the gap, improving the score and taking a forward-looking approach to how the metrics can evolve.
Robert Simpson
Senior Portfolio Manager of Emerging Markets Fixed Income, Pictet AM
What are some sustainable practices undertaken by the manager?
Some asset managers take on the responsibility to run their own businesses in the sustainable manner that they expect from the companies they invest in. At Pictet AM, internal sustainable practices include the following key achievements and initiatives:
  • Pictet Group is reducing its direct greenhouse gas emissions and aims to achieve a 55% reduction by 2030 compared with 2019 levels (an SBTi-approved target) with residual emissions mitigated through an approach that includes removing carbon from the atmosphere.
  • It is committed to a responsible purchasing policy by integrating ESG risks into its process.
  • Its balance sheet has been de-fossilized by following defined thresholds.
  • Its commitment to gender pay equity is confirmed by EDGE Certification Level 2, which includes an annual gap analysis as well as subsequent actions to enable progress.
  • The Pictet Group Foundation was established to fund impact-driven solutions that build resilient communities and ecosystems in the areas of water and nutrition.
Pictet AM Internal ESG Commitments
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MONITORING AND BENCHMARKING

Perhaps more so than in traditional investment management, sustainable and impact investing requires a close partnership between asset owner and asset manager. Below are some best practices for monitoring your asset manager’s approach to sustainable investing and benchmarking.

Investment Process Checklist
There are a number of ways to monitor how an asset manager implements an ESG-integration and impact-investment strategy. Those run the gamut from performance updates to directional shifts in ESG factors to progress in stewardship. Below is a sampling of questions that often come up in the monitoring process.

  • Did the portfolio manager change a weighting or sell a position because of ESG factors?
      •   If so, what was the rationale?
  • Within the portfolio, did the sector or industry tilts change?
      •  If so, what was the reason?
  • In proxy voting, how often did the asset manager vote against management?
      •   What were the reasons for its position?
  • What is the dialogue process on specific engagement issues?
      •   Is there an outcome?
      •   If the outcome failed, did the asset manager divest?
  • Are there any relevant updates to the data sourced externally or internally?
      •   How has the process changed, or will it change?
      •   Has the manager asked for any specific changes?

ESG Benchmarking
Most institutional investors track the performance of their active ESG strategies against a traditional stock or bond index and add material ESG key performance indicators (KPIs) to benchmark the strategy. Those KPIs can vary based on each asset owner’s mandate and goals.

Data Application
A lot of progress has been made in ESG data development, availability and standardization on the environmental side, including classifications, metrics, profiles and scenarios. However, “ESG is a broad catch-all phrase and at some point, in terms of data, we have to narrow it down and define what we’re really looking for,” Boscardin-Ching said.

The challenge today is to understand what the metrics and reporting actually mean and not apply them superficially. “Data is misleading without understanding its context,” she said. “Evaluating a portfolio’s ESG impact or profile is highly nuanced, and it’s impossible to do it based on the data’s face value. You need to see what’s behind the data to understand the true environmental profile.”

For instance, a company’s emission intensities are highly sector dependent. An investment strategy could have a low emissions footprint because it’s mostly invested in software or service companies, but that does not mean that those companies are actively contributing to the clean energy transition. On the other hand, a group of power utilities that have higher overall emissions may be actively phasing down fossil fuel assets and replacing them with renewables. “The real-life impact in terms of climate change mitigation [by these utilities] is much more impactful than any type of software company,” Boscardin-Ching said.

We’re in a phase where the data landscape is evolving quickly.
Steve Freedman
Head of Research and Sustainability, Thematic Equities, Pictet AM
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V

ACTIVE ENGAGEMENT AND STEWARDSHIP

Many institutional investors approach sustainable investing with a dual mandate. Their first goal is typically to direct capital to issuers that already demonstrate favorable ESG characteristics while avoiding companies that have a poor track record on environmental or social issues. Their second goal is to put issuers on a more sustainable path. This is where engagement comes in, taking diverse forms.

Direct Dialogue with Corporate Issuers
Asset managers can engage with companies through proxy voting or through consistent dialogue with a company’s management or board of directors to encourage change on a particular ESG issue. Active managers that interact frequently with issuers consider engagement as an integral part of their broader ESG strategy.

For example, in 2022 alone, Pictet AM led or supported engagements with 352 companies on 552 different ESG topics: 169 on environmental issues, 150 on social issues and 233 on governance issues. Pictet AM has detailed its engagement initiatives in its Responsible Investment Report.

Collaborative Engagement
In specific areas, it can be more effective for asset managers to act collectively rather than individually, particularly when the manager’s investment is relatively small in relation to the enterprise value of the company. Below is a sampling of key initiatives by asset managers:

  • Climate Action 100+
    This initiative, led by global asset managers and asset owners, engages with the largest global greenhouse gas emitters and with other companies that are driving the clean energy transition, to achieve the goals of the Paris Agreement. As of February 2024, more than 700 investors, responsible for more than $68 trillion in assets under management, had joined Climate Action 100+, according to the group, to work with companies in improving climate change governance, cutting emissions and strengthening climate-related financial disclosures.

  • Ceres
    Founded more than three decades ago, Ceres is a non-profit organization that works with capital market leaders to solve the world’s greatest sustainability challenges. Through a global collaboration of investors, corporations and other non-profits, it drives action and inspires equitable market-based and policy solutions in the global economy.

  • Access to Nutrition Initiative (ATNI)
    ATNI is an independent non-profit organization that works with corporations and other stakeholders to address the world’s nutrition challenges. Through engagement, research, partnerships and a range of private-sector accountability tools, it encourages businesses to do more to achieve good health through more thoughtful diets and improved nutrition.

  • FAIRR Initiative
    The FAIRR Initiative is a collaborative investor network that raises awareness of ESG risks and opportunities in the global food sector. It highlights sustainability issues linked to intensive animal production and seeks to minimize risks within the broader food system. FAIRR, an acronym for farm animal investment risk and return, provides high-quality research, facilitates collaborative engagements and coordinates policy action. As of February 2024, it had more than 400 members globally that represent more than $70 trillion in combined assets, according to the group.

Broader Stewardship Efforts
Asset managers and asset owners also participate in industry collaborations that seek to raise awareness, promote ESG best practices and further the body of knowledge related to sustainable investing.


ESG-Related Organizations, Initiatives and Partnerships in the Investment Industry
Pictet Group and/or Pictet Asset Management supports and actively participates in international and national initiatives, organizations and partnerships including:

Sample of ESG Scorecard

Source: Pictet AM, December 2023  

 

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LOOKING AHEAD

There is an acknowledgement that sustainable investing based on ESG factors and metrics provides better risk-return investment profiles. Across the globe, regulators, asset owners and corporations are working in tandem to bring more robustness to ESG investing with a focus on positive investment outcomes and more effective risk management. Investors are embracing several sustainability themes, including the energy transition and biodiversity, to capture the great number of opportunities in related industries. They are focused on the quality factors that can boost the potential for long-term effectiveness of corporations to achieve sustainability goals.

Furthermore, as ESG-related data and metrics are developing, and the lack of standardization continues to be a challenge, many corporations have taken sustainability more seriously by hiring dedicated staff, modeling exposures, increasing disclosures and pivoting to adopt new business opportunities in the transition to a renewable economy. Asset owners are applying new sustainability frameworks with a greater level of thoughtfulness and precision throughout the investment decision-making process.

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GLOSSARY

Active ownership
This refers to investors addressing the ESG policies of companies and other issuers. It includes proxy voting at shareholder meetings and engagement with issuers and third-party portfolio managers on priority themes that, for Pictet AM, include climate, water, nutrition, long-termism and other material ESG issues.

Best-in-class
An investment approach based on a sustainability rating in which a company’s or issuer’s ESG performance is compared with that of its sector peers. All companies with a rating above a defined threshold are considered as investible. 

Engagement
An investment approach based on a sustainability rating in which a company’s or issuer’s ESG performance is compared with that of its sector peers. All companies with a rating above a defined threshold are considered as investible. 

ESG
ESG stands for environmental (for example, energy consumption, water usage), social (talent attraction, supply chain management) and governance (remuneration policies, board governance). ESG factors form the basis for different sustainable-investing or responsible-investing approaches.

ESG factors
ESG factors are ESG data that indicate both risks and opportunities, such as sustainability risks and principal adverse impacts.

ESG focused
Investments that integrate ESG factors in order to enhance their risk-return profile and promote environmental and/or social characteristics. Promotion seeks to increase exposure to issuers with low risks and high opportunities while decreasing or avoiding exposure to issuers with high risks or low opportunities. An exclusion framework applies, alongside a focus on issuers with good governance, and active ownership is carried out where feasible. ESG focused is equivalent to an article 8 SFDR.* Also see active ownership, ESG factors, ESG integrated and exclusionary screening.

ESG integrated
Investments that integrate ESG factors in order to enhance their risk-return profile. ESG integration includes ESG data availability, a defined framework, ESG data usage in the investment process, monitoring and disclosure of the ESG role in the investment process. ESG integrated is equivalent to an article 6 SFDR* and may invest in securities with high sustainability risks.

Exclusionary screening
An investing approach that excludes companies, countries or other issuers based on activities considered not investible. Exclusion criteria (based on norms and values) can refer to product categories (for example, weapons, tobacco), activities (animal testing), or business practices (severe violation of human rights, corruption). Also called negative screening. Please refer to Pictet AM’s responsible investment policy for more detail.

EU taxonomy
A classification system created by the European Parliament & Council that establishes a list of environmentally sustainable economic activities.

Greenwashing
A term used to describe misleading claims by corporations and asset management firms about the ESG credentials of their practices and investment strategies.

Impact investing
Investments intended to generate a measurable, beneficial social and environmental impact alongside a financial return.

Positive impact
An investment approach that integrates ESG factors in order to enhance its risk-return profile, promote environmental and/or social characteristics and target activities that are environmentally and/or socially sustainable. Examples of thematic strategies are clean water or clean energy. Positive impact is equivalent to an article 8 or 9 SFDR.* Also see engagement, ESG factors, ESG focused, ESG integrated, exclusionary screening, sustainable investments and thematic investing.

Principal adverse impacts (PAIs)
Negative, material, or potentially material effects on sustainability factors that result from, worsen, or are directly related to investment choices or advice performed by a legal entity. Examples include greenhouse gas (GHG) emissions and carbon footprint.

Principles for Responsible Investment (PRI)
The United Nations’ supported investor network that promotes and supports ESG integration into the investment and ownership decision process. Since 2006, the 100 original signatories have grown to more than 5,300 worldwide as of January 2024.

Proxy voting
In the context of the shareholder’s right to vote on certain corporate matters, proxy voting is the option for the shareholder to cast a vote without having to attend the company’s annual and special meetings to do so.

Responsible investment
Any investment approach that integrates environmental, social and governance criteria into the selection and management of investments. It takes many forms, such as best-in-class investments, ESG integration, exclusionary screening, thematic investing and impact investing.

Sustainable Finance Disclosures Regulation (SFDR)*
The European Union’s set of disclosure regulations that requires asset managers and other financial market participants to be transparent in reporting sustainability risks in their investment processes as well as potential adverse impacts of investment decisions on sustainability factors.

Sustainable investments
An investment in an economic activity that contributes to an environmental and/or social objective, which might be aligned with the EU taxonomy, a classification system created by the European Parliament and Council that establishes a list of environmentally sustainable economic activities. Usually measured by the percent of revenue contribution of the activity, given it abides by the do-no-significant-harm principle. Targeting means having sustainable investment as its main objective.

Task Force on Climate-Related Financial Disclosures (TCFD)
The Financial Stability Board released the TCFD framework in 2017 to help public companies and other organizations disclose climate-related risks and opportunities in a more effective, standardized manner in their reporting processes.

Taskforce on Nature-Related Financial Disclosures (TNFD)
A private-sector initiative that provides a global framework to help organizations manage and disclose their nature-related dependencies, impacts, risks and opportunities. Its guidance enables integration of nature into business and financial decision making.

Thematic investing
Investment in businesses contributing to sustainable solutions in environmental and social topics. Environmentally related investments include renewable energy, energy efficiency, clean technology, low-carbon transportation infrastructure, water treatment and resource efficiency. Socially related investments include education, health systems, poverty reduction and solutions for an ageing society.

United Nations’ Sustainable Development Goals (SDGs)
The set of social, environmental and economic targets agreed upon by the United Nations for its member countries (such as zero hunger, gender equality, clean water, climate action). The SDGs are used by businesses to report on their sustainability efforts and credentials, and by investors who want to know how companies are exposed to SDGs.

*Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (SFDR).

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Quiz

Test your knowledge of ESG investing based on the information provided in this Guide. It offers a brief recap of some key areas of information related to ESG investing.

 
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