KEESA
We're hearing a lot about the possibility of a market correction in the near term. Now, what might this mean for SGN?
KEESA
How have ESG portfolios performed when there is softening or transitory trend and what do investors need to think about today, especially in this low yield environment?
KEESA
We're here to discuss this and answer some of these questions.
KEESA
Is Nikita Singhal, Nikita is managing director.
Co head of sustainable investment and ESG at Lazard.
She is also a friend of their Refinitiv Sustainability Perspective podcast and was our very first interview E two years ago, so we gave you a special welcome back Nikita.
Thank you for joining us.
So loads to catch up on here. As I mentioned, there's quite a bit of talk around the expectation of a market correction as we head into Q4. Just how resilient can we expect ESG funds to be in this market?
NIKITA
That's a great question, and I would frame it kind of across three pieces.
One is coming back to the definition of ESG, which you know as you know there are so many definitions about in this relatively nascent.
Keesa
You know industry at least nascent compared to the history of financial markets.
So we'll talk a little bit about that.
The second is because of its definition.
It's the relevance of ESG across market cycles and investment styles.
So for example, growth and value and lastly recent empirical studies to support this hypothesis and so starting with the definition really, it really depends on when we talk about.
Keesa
ESG often people use different definitions at Lazard Asset Management.
Keesa
We define ESG as the.
Keesa
Systematic incorporation of environmental social governance risks and opportunities, and to try and understand how these environmental social issues are getting priced into the market to try to price them in before the market prices them in before its consensus and therefore ultimately improve investment outcomes for our clients over a long term.
Keesa
When that is the definition of ESG, then it's not about a specific market cycle.
Keesa
A bowler bear market, a specific style, whether your growth or deep value or relative value, but much rather about finding ways to think about in a in a bottom up fundamental way how a specific environmental or social or governance.
Keesa
Issue is impacting the investment you're looking at and and this the research actually supports this so you see longitudinal research studies showing how companies who have who score high on certain sustainability attributes have actually outperformed over others in the long term.
Keesa
The most popular.
Keesa
Study I read about these days is by Gunther Frieden, the Journal of Sustainable Finance and Investment. And this is going back to 2016.
Keesa
So it's not just you know in the in the recent years where there was meta analysis of more than 2000 studies of the impact of high ESG ratings on corporate financial performance.
Keesa
And that showed, you know, over a 63% positive coral.
Keesa
There's similarly other studies in the Journal of Applied Corporate Finance, showing that that by removing the bottom 10% or 25% of companies by ESG ratings, you could.
Keesa
You could have a portfolio yielding higher returns and and having lower risk.
Keesa
Similar studies have been done by index providers like MCI to demonstrate.
Keesa
How ESG fund performance can be quantified and how ESG factors can cumulatively contribute to almost 2% of the top 20 ESG funds returns over the last 10 years.
Keesa
But the question that you asked is really, you know what happens when there is a market correction and interest.
Keesa
I mean, we have had a bit of that in the last two years, and so there's there has been research that was conducted in the times of recent market turbulence. So as an example, the S&P global market intelligence found that funds investing in.
Keesa
Companies based on their ESG ratings are quote unquote, relative safe havens in economic downturn.
Keesa
And what it did was it analyzed the performance of 17 ESG focused ETFs and mutual funds and that have more than 250 million in assets through that turbulent period of January through May 15 of last year and all but three outperformed the S.
Keesa
And P5.
Keesa
100 which you know is widely considered one of the better best representations.
Keesa
A lot of people when they discuss ESG performance, and I'll pause here, have have attributed the recent success and kind of outperformance of ESG strategies to sector exposures, specifically, the tendency to be underweight energy, especially fossil fuel extraction and being overweight technology and and I think it's worth just a.
Keesa
As a final point, kind of debunking this notion.
Keesa
And there is a recent academic study by Harvard Business School by professor at Harvard Business School that found that companies who responded to the current pandemic with a greater focus on stakeholders.
Keesa
Including once employees and your supply chain partners actually saw better returns during the 2020 market correction.
KEESA
I definitely can appreciate the thought about focusing on stakeholders and really looking beyond the typical lens that we look through, but exposing as you say.
KEESA
Employees and also looking at suppliers there. I'm curious Nikita taking a step back into those SuccessFactors. Some people believe it has to do with sector exposure.
KEESA
Other people really point out that when there is a tilt toward ESG, understanding the risks and the opportunities.
KEESA
There that there can be still apple generation.
KEESA
I'm wondering in today's environment, in this low yield environment and it's a low yield environment so many places.
KEESA
In context of G, let's think about the significance of Europe, where there is a lot of traction around green bond issuance.
KEESA
How can a manager build a basket where green bonds sustainability linked bonds are the focus for them in this type of environment where there are so many regions that are experiencing a similar.
KEESA
Low yield environmental opportunity.
Keesa
Yeah, great question and the way I would frame that is.
Keesa
I really think that if you if you call it green, conscious investing or investors who proactively want to invest in in in fixed income instruments that have exposure to this low energy.
Keesa
The low carbon transition that the world is expected to go through.
Keesa
Either from it from a personal motivation standpoint, or from an understanding that.
Keesa
This is where the world.
Keesa
Is headed and and credit may be impacted by.
Keesa
But we really believe at Lazard Asset Management that green conscious investing really requires skilled active management, and I'll tell you why.
Keesa
Coming to, you know your question about the first and foremost is because of that interest rate exposure that you spoke about spoke of the the composition of the green bond universe.
Keesa
It offers a pretty helpful example of.
Keesa
How interest rate exposure, for example, can impact passive ESG strategies by focusing only on labeled green bond issues.
Keesa
We may be overexposed as we may overexpose an investor or a client of ours to unintended interest rate.
Keesa
Risk and passive passive investors in particular could end up being more exposed than they bargained for to Europe's low and negative prevailing interest rates.
Keesa
So if you just look at the green Bond universe today, European issuers account for almost 40% of the value of green bond issuance since 2007 according to this is, according to the climate.
Keesa
Bond initiative and over 60. I think it's about 64% of the bonds in the Barclays Green Bond Index are issued.
Keesa
In euros, so that's you know by by just selecting green bonds, that's.
Keesa
Those are some of the.
Keesa
Issues that you can run into, which leads me kind of to.
Keesa
My second point is that you could still do this in in a genuine a way while still achieving your risk return objectives by not missing out on unlabeled bonds.
Keesa
Passive green bond investors.
Keesa
They tend to miss out on these.
Keesa
Out fixed income investments there.
Keesa
There are fixed income investments that may not be labeled officially as green or social bonds.
Keesa
But there are many that provide options for achieving that diversification.
Keesa
Being able to source yield, and managing duration all within while trying to achieve.
Keesa
Also, you know a sustainably conscious portfolio, so it is very much possible, but you need to have a an investor and asset manager who can do that bottom up due diligence both on the on.
Keesa
On the credit side, but also on the sustainability side to be able to vet that the use of proceeds of these bonds makes sense.
Keesa
It's in line with the overall objectives of the enterprise that's issuing the bar.
Keesa
And that kind of leads me to my last point, which is you need active management to untangle the current greenwashing challenge that that we are all facing.
Keesa
Many issuers, both corporate and sovereign issuers around the world.
Keesa
We feel sometimes they're paying lip service to environmental consciousness without really any meaningful results.
Keesa
You see this with certain oil majors or utility companies that tout their investments in renewable energy, for example, but they as an entity as an enterprise may still be vulnerable to the stranded assets problem as the world transitions towards cleaner sources of energy.
Keesa
And so we believe that the best active managers actually tap into this into their in depth fundamental research to determine which issuers are serious about sustainability and which army reek merely kind of trying to ride the wave of this pro environment sentiment.
Keesa
One example is our global fixed income team at Lazard, which purchased its first green bond.
Keesa
In 2015, and more than 20% of that portfolio today is invested in labeled green social and sustainable.
Keesa
Ones, but far beyond that as I described, there is an attempt to try and unlock, you know, opportunities both on the sustainability and yield side to to look at unlabeled bonds and to try and.
Keesa
Strip away the.
Keesa
Wheat from the chaff in terms of.
Keesa
The the the.
Keesa
Sustainability claims that a lot of issuers have versus.
Keesa
Those that have.
Keesa
You know, really legitimate use of proceeds, many of whom you know, have proceeds that are earmarked for certain qualified projects which we really like, and and and some of which are even, you know, have second party opinions on on the issuance.
Keesa
These are from firms like Cisero, Sustainalytics, and Vizio, which are all in compliance with the.
Keesa
The ECMA green social bond principles.
Keesa
So that's something.
Keesa
That we would we would advocate.
KEESA
More so, and this is great.
KEESA
I appreciate the thought about the pro environment sentiment and I think that cost is we're talking about bonds now, but we can also look at equities and really look at what's going on in a couple of specific sectors.
KEESA
Now I'm thinking about the oil and gas sector and the transition toward.
KEESA
Renewable energy. I'm wondering specifically now is we're getting closer to COP 26. What types of expectations may be set for oil and gas and renewables? And do you think that we should expect specific outcomes after COP 26 in that sector?
Keesa
Yeah, I mean this is a very tricky question.
Keesa
I I I'm tricky as I mean I could say complicated and challenging and I certainly don't have a clear answer, but I what I can present.
Keesa
To you is.
Keesa
The you know potential arguments on both sides and and and and the challenges that I think I see unfolding with as countries make increase.
Keesa
And ratchet up their commitments, their nationally determined contributions. You know. Just today, I saw a report out by our energy analyst talking about how energy prices are like. Almost 8% of world GDP.
Keesa
And this is driven primarily by a 26% plus increase in Asian LNG prices. This is probably only the second time that this has happened since 2008, and energy prices are at 87% above the two year moving average. This could have a major destabilizing effect. You know, impacting credit impacting.
Keesa
Counterparty risk, and even at a societal level, destroying disposable income budgets for for homes.
Keesa
And all of this is happening and against.
Keesa
The backdrop of.
Keesa
Cop 26 that which is, you know a meeting held for the members of the Paris Agreement to come back.
Keesa
And as I said, ratchet up their agreements.
Keesa
There are some very positive things that have happened in the world in the last 10 years.
Keesa
The the recognition of the urgency of climate change.
Keesa
And and this is, you know, with the recent IPCC report, the Intergovernmental Panel on Climate Change, it has become even more urgent to quickly try to decarbonize our economies.
Keesa
And we've also had real technological breakthroughs, so governments are recognizing the urgency. There is an ability to actually significantly increase growth, global renewable energy, power capacity, and this is on the back of the cost effectiveness now of renewable technologies. You know almost a 89%.
Keesa
Drop in solar energy and 70% drop in wind energy costs since just 2009.
Keesa
So very some very positive factors, but on the back of it this transition that is inevitable in many ways is going to result in dislocations and particularly what I am concerned about is how do we make sure that this transition that is increased.
Keesa
You know it is is inevitable and we are trying to figure out what's the.
Keesa
Quickest time horizon over which to have the transition as a planet that it is just and we don't have situations you know across emerging markets.
Keesa
But even in developed markets you saw this just a few years ago with the Jean Movement and.
Keesa
France, if there is pressure to transition our economies at a very quick pace a there is a there's quite a like there's quite a chance that the inflationary effect of trying to transition economies quickly will fall to the people who can't afford it at all.
Keesa
And and you see that in the rising costs of commodities.
Keesa
In fossil fuel commodities already, so it's a really delicate balance.
Keesa
I think that I I really like to follow the work of the inevitable policy response.
Keesa
This is a project that.
Keesa
Is it is an aim to help prepare institutional investors like us at Lazard for portfolio risks and opportunities?
Keesa
So anyone interested in that, I would highly recommend they take a look at the at the inevitable policy response.
Keesa
This was commissioned by the PRI, the principles for responsible investing in 2018, and it's led by two firms that.
Keesa
David Economics and the energy transition advisor.
Keesa
But but they've done work to try and understand under the back against the backdrop of the urgency to respond to climate change and to try and mitigate some of that.
Keesa
The highest probability risks of climate change unfolding over the next.
Keesa
Even you know medium to long term, not just a 20 year horizon, but just in the next 10 years.
Keesa
What is the expectation of the next wave of announcements for net zero?
Keesa
So they predict that the United States.
Keesa
As well as countries like India and Australia will announce their net zero emissions targets by as early as 2023.
Keesa
They have pretty similar projections for carbon pricing, where where they they predict that carbon border adjustment mechanisms which are already being heavily discussed, and I suspect.
Keesa
Will be a big part of the cop. 26 discussions. Uhm these see bands from tier one countries are likely to put pressure on other countries to implement more ambitious carbon pricing.
Keesa
And then, most notably the impact on.
Keesa
Coal, I mean we were.
Keesa
Talking about oil and gas, but really.
Keesa
With with cold.
Keesa
Coming under new unabated coal, largely becoming UN investable, you know, by 2025 in almost all countries and how several several states even in the country like India which is so dependent on coal, almost 73% of generation in 2018 was on what came from coal has had states.
Keesa
Like good Roth and shut these good that have set the objective to end new coal generation.
Keesa
So I just kind of would summarize this where it is, you know a very complicated equation to try and understand what exactly the the direct impacts are going to be.
Keesa
But as.
Keesa
Fundamental bottom up investors.
Keesa
Our goal is to make sure we try and have a probability adjusted view of what's likely to happen in the world in terms of regulation and this kind of inevitable policy response against the backdrop of how companies are responding to them and how resilient they're going to be so very.
Keesa
Very exciting and it's it's times.
Keesa
Ahead I I would say.
KEESA
Excellent, what a great point to end on so we don't just talk about sectors and industries here, but when looking at mitigating climate change there are practical realities and tradeoffs as it relates to the decarbonization of the economy.
KEESA
When we look.
KEESA
At regions emerging countries, emerging economies, and what they're being asked to do in context of the resources that they have.
KEESA
Also very clear defining what ESG is and really sticking with that definition, the one that you gave to us.
KEESA
Nikita, the systematic incorporation of environmental, social and governance risk.
KEESA
And opportunities in understanding how these environmental and social issues are priced into the market using that information to improve investment outcomes for your clients long term and really at the end of the day, it's all about finding ways to think about those ESG issues, how they impact the investments that you're looking at.
KEESA
And really, looking at the possibility of in all markets in all types of environments, including the one we're in now, how ESG can help?
KEESA
An investor to outperform the market and great information.
KEESA
Great background and data that you gave us around how ESG can be used to help outperform and generate alpha.
KEESA
As always, Nikita single.
KEESA
Thank you so much.
KEESA
Nikita Singhal from Lazard.
