ESG Investing for Endowments and Foundations

11 November 2019

David Osfield, Fund manager at EdenTree with responsibility for managing investments globally for charities, was recently interviewed by a climate change consultant on the topic of embedding environmental, social and governance (ESG) factors in investing for endowments and foundations. From the sharp rise in interest in ESG investing, to the unexplored opportunities for investors, David gives some insight into how endowments and foundations can approach the sometimes unfamiliar world of responsible and sustainable investing.  

I understand that EdenTree has been focussed on responsible and sustainable investing for over thirty years. What do you think has caused the recent sudden interest in ESG, from the public, investors and asset managers alike?

David: As a society we can be conditioned into short-termism; failing to address serious issues that can’t be solved immediately for fear of missing out on what’s perceived to be results that look good now. The problem is, such an approach can ignore longer-term imbalances which can be far more impactful, and harder to correct when it starts to go wrong.

More recently however, we have seen an engaged movement from the next generation that is driving the conversation around the environment forward. It is understandable as these are the people that will live to suffer through the effects that our actions are having on the environment, rather than the policy makers that are in power now. The attitude these young people have is clear; ‘this needs to be solved, yesterday’. But they’re not simply rebelling for the sake of it. They are seeing proof that the world is being irreversibly damaged; the volatility of the world’s climate, the increasing frequency and strength of natural disasters, the impact a rise in temperature will have on sea levels, and they won’t accept that it is right to continue on in the same way. As responsible and sustainable investors, we see this too. Our insightful research illustrates the persistence and longevity of these issues, and so investing in these companies that contribute to such problems is both irresponsible to do in terms of the impact that they have on wider society, but also financially likely to deliver lower returns due to the structural challenges.

Overall, the financial community has been, and continues to be, notably lagging in this area. There are still those that deny the situation out of convenience and see ESG investing as a ‘fashion or fad’ topic that will dissipate. EdenTree think differently, and see a fast growing opportunity set. We see particular potential in the companies transitioning to more sustainable models of production or that, rather than fuelling the world’s problems, are addressing them with practical solutions. In the long-term, these are the companies that will not only survive, but will thrive.

Do you think it is enough for an endowment or foundation to simply divest from harmful areas such as tobacco or fossil fuels? Or should the approach be more holistic?

David: Exclusion is one option for investors but it is a fairly basic, commoditised approach. The focus here is on taking things out, and this is where the historic research implied this was detractive from an 

investment return perspective. However, we see much greater potential in a more proactive approach, which enhances and aligns an endowment or foundation’s mission with the companies it invests in.

We also believe it will be much harder to solve the world’s problems if we all take our own piecemeal approach. Take a charity that is focussed on lung cancer that wishes to exclude tobacco only from its portfolio as an example. Given the charity’s mission, certainly it makes sense to do so. But the charity’s mission can be affected by more than one issue. How does air and water pollution by corporations, or the behaviour of pharmaceutical companies also affect their mission to eradicate lung cancer? Or a charity focused on issues of social injustice and slave labour that wishes to divest from companies with a poor supply chain. Why not also invest in support of the companies that are seeking to empower and facilitate the communities they work in around the world? These companies will create thousands of jobs and will have more rigorous policies in place as they understand what it takes to thrive in today’s climate.  

As a charity, you can align your investment with your mission without sacrificing return. In fact, research is increasingly showing investors can gain superior risk-adjusted returns over the long term through a holistic responsible and sustainable approach rather than one that just seeks to exclude.

How can foundations ensure asset managers are doing what they’re supposed to be doing? What kind of questions should they ask?

David: If taking an active approach, endowments and foundations should feel confident that the strategy they’ve discussed with their asset manager is in alignment with their values and mission. Questions to ask your asset manager include ‘what proportion of the portfolio is achieving its targets, where ESG is concerned?’ A headline comment on a ‘return-driving ESG portfolio’ is no good if only 40% is screened or ethically invested. If an asset manager has started to promote ESG products overnight then question why, the processes involved, and what has changed in the underlying portfolio as a result? Are they merely following a trend or do they have sufficient research in place for stock selection? Try and understand the types of questions your asset manager is asking the companies you invest with. Are they engaging with these companies or analysing them via a third party data supplier? Given the non-standard nature of ESG disclosure, quantitative scoring is far from a complete picture and good policies don’t necessarily mean good implementation and practice. Your asset manager needs to have a holistic insight to ensure that further down the line, this seemingly ‘good’ company isn’t contributing to a wider problem. At EdenTree, we believe in active stewardship, voting and engaging with the companies we invest in.

Overall, the financial community has been, and continues to be, notably lagging in this area. There are still those that deny the situation out of convenience and see ESG investing as a ‘fashion or fad’ topic that will dissipate. EdenTree think differently, and see a fast growing opportunity set. 

Surely the most responsible and sustainable companies are, or soon will be, priced at a premium to those who are not? What is your advice for endowments and foundations?

David: There are certainly companies that are already well ahead, and others that are rapidly moving in the right direction. As endowments and foundations, and indeed other types of investors, adopt responsible and sustainable investing, the underlying companies could experience a degree of valuation re-rating due to their positive contributions and perceived outlook for growth. As more capital is directed towards these strategies, the degree of scarcity will rise, and one needs to be mindful of group think and pockets of excessive valuation. Part of the value an experienced responsible investment manager brings is to identify these companies early on, so that clients can benefit when the market later recognises the opportunity.  

Finally, what is your advice for first time ESG investors?

David: There is a huge level of circulatory here that makes a lot of sense for charity investors. If you invest in the companies with the outcomes your charity itself focuses on, you are contributing to your goal in more ways than one. As first time investors, don’t be afraid to ask questions and consider the options available. Think about the broader mission of your charity and the ways you would like your investments to reflect that. Certainly it is right for endowments and foundations to focus on their mission and values; however there is so much more your assets can do to solve some of society’s biggest problems, and certainly not contribute to the problem. In todays’ current climate we need charities and the services they offer more than ever. Adopting an even more holistic approach can ensure your charity’s aims are being fulfilled, not only through grants and projects, but directly through your well-aligned investment portfolio.

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