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The future of sustainable investing

Dean Anderson discusses Kernel’s new sustainable funds and what they offer for advisers and their investment clients.

BY DEAN ANDERSON

You’ve recently announced Kernel’s Sustainable Funds, what are they?

We have launched three sustainable funds which are: Kernel NZ 50 ESG Tilted, Kernel Global Green Property, Kernel S&P Global Clean Energy. All of the funds are available across the major wrap platforms, extending our product range to 11. This presents an opportunity for investment advisers and wholesale investors to couple sustainable investment with the benefits of low-cost index investing.

Why have you decided to add ESG funds to your product suite?

We have always wanted to develop a New Zealand ESG fund, however, we didn’t want to just cut SkyCity. Until recently the data coverage and quality was not sufficient to enable an effective strategy to be developed.

Since S&P DJI’s launch of global ESG indices in 2019 and the extended coverage of the Corporate Sustainability Assessment framework, we reached a tipping point where an effective strategy could be developed.

The resulting NZ 50 ESG Tilted index will not only exclude certain sectors but tilt towards or away from companies based on other elements such as workforce diversity, cyber risk and systems through to greenhouse gas emissions.

There appears to be some confusion around what is an ESG fund. What is your definition?

There is a lot of misuse of the terms sustainable, ESG, impact, ethical and socially responsible. In part this is due to a lack of global standards in terminology.

Historically, SRI investments have used an exclusions strategy; excluding ownership of “sin stocks” like tobacco or gambling.

ESG investing often has these same exclusions, but it might also use a scoring system across the E, S and G factors of each company to then increase investment in companies which are calculated to be creating a positive impact.

Given many of these terms are used interchangeably, yet they can be doing very different things, it’s important to look at the methodology of the investment strategy to ensure it aligns with your clients’ objectives.

How has passive investing evolved to capture ESG?

What most won’t realise is that the shift towards ESG index strategies is fairly new. S&P DJI only launched the S&P 500 ESG Index in 2019. What we have seen recently is:

• a shift from pure exclusionary investment strategies towards integrated strategies

• the use of multiple data sources to power ESG strategies

• more targeted measurement of ESG strategies against desired objectives

• a move towards climate solutions or adaptation, as well as mitigation.

This has fuelled the expansion of ESG indices and now the first ESG equity index for New Zealand.

How are ESG scores calculated?

The factors used to measure ESG performance can vary, but typically include things such as:

• Environment: Greenhouse gas emissions, waste and pollution, water use, land use

• Social: Workforce and diversity, safety management, engagement with communities

• Governance: Governance structure and oversight such as board composition, code and values, transparency and reporting, cyber risk

Often multiple data sources and providers are used in the calculations, including Trucost (carbon), Sustainalytics, Carbon Disclosure Project, Corporate Sustainability Assessment, and GRESB in the case of REITs and infrastructure.

Each company is given an ESG score, which is the weighted average of all criteria scores and their respective weights. Total ESG scores range from 0-100, with 100 representing best performance.

What sort of tilts do the funds provide in a portfolio?

The Kernel S&P Global Clean Energy fund can be used as a satellite exposure for those that want to lean into a deep green philosophy.

The NZ 50 ESG Tilted fund will be an ideal building block for an NZ equity allocation, and our Kernel Global Green Property fund is an exceptionally cost and tax-efficient option for a global real estate asset allocation.

Is there much investor demand for ESG funds?

We are seeing a significant global shift of assets into sustainable strategies. More investors are considering the impact their investment has in shaping the world they live.

Flows into listed ESG investment funds in the US in 2020 reached $51.1 billion, which was more than double 2019 levels and a nearly tenfold increase from flows into ESG funds in 2018, according to Morningstar Inc.

The shift to sustainable strategies will persist, as social and climatic issues continue to rise. There are also regulatory changes driving massive investment towards companies better prepared to tackle climate risk, as countries transition to a renewable, low carbon future.

Why are investors caring about this?

Aside from concerns about environmental and social issues, investors are also looking at sustainable investing as a way to make longer-term strategic investment decisions.

When ESG was first coined as a term in 2005, it was considered novel and perceived as coming at the expense of better returns.

However, numerous studies have shown that companies that have adopted ESG policies have outperformed those that don’t. Companies that are thinking decades in the future and considering their impact on the world may be better positioned to adapt to change and deliver greater long-term returns.

Does ESG work for passive funds when some would argue it is the domain of active investors?

The critical question we ask ourselves with any ESG strategy is can we trust the data. Quality, reliability and coverage of the data is what is needed to develop a robust ESG investment strategy.

We’ve seen a lot of M&A activity in this sector as global providers look to build out comprehensive databases that enable providers to benchmark, amend and compare individually reported data points.

For example, each year S&P Global conducts the Corporate Sustainability Assessment (CSA), an analysis of over 11,000 companies. The CSA has produced one of the world’s most comprehensive databases of financially material sustainability information and serves as the basis for the scores that govern S&P DJI’s ESG indices.

I would argue that the direction ESG scoring is moving is more aligned to index strategies – transparent methodologies, removing human bias and judgement and limiting self-reported risks.

The net result is a passive product that leverages big data from the world’s largest databases to deliver a more robust outcome at a lower cost. A

If you would like more information on Kernel’s investment funds, please contact:

Dean Anderson dean@kernelwealth.co.nz 021 828 427