Breaking Down Trends in ESG Products

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Aaron White

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Aaron White, vice-president of sustainable investments at CIBC Asset Management.

Addressing the ESG market trends we’re seeing today, the growth trend is getting lost in the noise of thematic and specific ESG strategies in ESG integration, and the tremendous adoption globally. The number of UNPRI signatories who have committed to adhering to their six principles has surpassed 4,000 institutions representing well over $110 trillion. This is changing the way asset owners and managers formally consider nonfinancial risk, and it’s helping shape valuations across sectors, industries and geographic regions.

Investors need to be more conscious of how their managers consider these factors and how ingrained the process is within the investment process. At CIBC Asset Management, for example, we have integrated the analysis within our broad analyst coverage, as we believe that individuals that cover companies and issuers from the traditional financial sense understand those entities and the sectors or industries with which they operate best, and are most equipped to evaluate the most material ESG risks.

They’re also more likely to factor that analysis into their holistic evaluation, ensuring that ESG risks are fully integrated in the valuation process. We’re currently seeing scrutiny directed toward how we manage ESG risks. And I believe that as ESG integration continues its wide adoption, we will see more regulatory and investor interest on the authenticity and results related to how managers consider these factors within their process.

Switching gears to trends we’re seeing from a product solutioning perspective, we’ve seen a significant level of interest in environmental issues and specifically fossil fuel divestment. This is an area of debate currently related to how to best influence an energy transition. But it is clear that investors are focused on divestment. In the last year, we’ve seen university endowments and other significant institutional investors make divestment commitments. We at CIBC Asset Management have seen a meaningful increase in clients looking for us to facilitate that divestment.

There are two key drivers to this theme. Firstly, a values alignment objective where investors believe that divestment advances their goals of an energy transition. And secondly, an investment thesis where investors believe that traditional energy sector cannot offer growth as transition becomes a larger global focus.

As investors consider divestment, we’re also seeing clients focus on emission reduction within portfolios and either relative to index goals or sliding reduction objectives over time. The challenge with these strategies is that currently the data is not perfect. However, as disclosures and reporting standards evolve, I think we’ll start to see increases in emission-focus solutions.

That plays into another key theme that we’re seeing in the market today: carbon offsets. Many companies, issuers and even asset managers are seeing offsets as an option to accelerate their net zero commitments, especially given the current market price for these offsets that are relatively affordable.

As we work towards net zero in 2050, offsets certainly will play a role. However, they should not be the starting point. We need to first reduce emissions through operations and a real energy transition — perhaps using technology like carbon capture can play a significant role — and then use offsets as a last mile type solution, reducing the inevitable final emissions. We have seen lots of net zero strategies released into the market lately, including strategies that simply purchase offsets of the estimated scope 1 and 2 emissions of index constituents. I would caution investors on many of these approaches and advise they understand how net zero commitments are being achieved.

Another key development are ESG bonds. In Canada, we’ve seen a significant growth in green bond issuance, which have a use of proceeds approach. These issues are not very inclusive at the issuer level, as companies have to have green projects to invest the proceeds into. We have yet to see any sustainably linked bonds issued in the Canadian market, but are seeing significant growth in this area in Europe. These bonds have sustainable targets integrated into the covenants of the bond that assess penalties to the issuer. They do not need predetermined sustainability targets.

All of these bonds typically trade at a slight premium to the issuer’s traditional debt and therefore create incentive in cost of capital for the company to make these commitments. I think we’ll see an acceleration and issuance, and, as we do, an increasing number of investment solutions catered to investors.

Finally, the most interesting trend we’re seeing is in impact investing. These investment strategies have a primary focus of generating nonfinancial return for its investors while attempting to deliver either market or concessionary financial returns. There’s a tremendous amount of industry work, and we at CIBC Asset Management are focused on developing a framework for assessing outcomes and linking those outcomes to impact. For example, there’s been quite a bit of work done on linking investments to the UN Sustainable Development Goals and targeting specific objectives — things like climate, access to health care, gender equality among others.

These strategies will have a strict tracking and reporting related to those nonfinancial impacts and can help investors achieve their personal goals aligned with their values. While there is a limited amount of investment strategies in this area today, as research and investment processes evolve, I would expect this to be the next frontier of ESG investing.