ESG Clarity COP26 guide

PARTNER CONTENT | WELLINGTON MANAGEMENT

The what, where and how of impact

Wellington’s impact portfolio managers Campe Goodman and Tara Stilwell answer questions on impact investing and how to access it

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Q: What is impact investing?
A: Impact investing provides funding to companies and bond issuers actively addressing the world’s major social or environmental challenges. Impact investors like us intentionally direct capital with the aim of generating positive outcomes for people and the planet while seeking to deliver competitive investment returns.

Q: Where do you find opportunities?
A: We focus our research on 11 impact themes, centred on life essentials, human empowerment and the environment. Life essentials covers affordable housing, clean water and sanitation, health and sustainable agriculture. Human empowerment seeks to address the digital divide, education and job training and financial inclusion, as well as safety and security. The environmental category encompasses alternative energy, resource efficiency and resource stewardship.

Q: How do you define a company as ‘impact’?
A: To be considered for our impact approaches, each potential investment must meet a high bar of alignment with our impact themes. The impact case must be material, with the majority of a company’s revenues or business activities advancing one or more of our themes. The impact of the potential investment must also be additional, addressing a specific need that is unlikely to be met by other agents, be it competitors, governments or non-governmental organisations.

We believe it is also important to understand a company’s or an issuer’s holistic impact. For example, with green bonds, we scrutinise not just the use the bond’s proceeds will be put to, but also the issuer’s wider business activities. With government bonds, we only invest where the proceeds are being used specifically to address one or more of our impact themes.

We also assess any potential investment for unintended negative consequences that would outweigh its positive impact – for instance, the impact of a new recycling facility on local communities or the environmental implications associated with the data storage involved in digital solutions.

Finally, the impact case for each investment must be measurable so that we can quantify and report on its progress over time. We believe investors must be able to analyse, track and measure impact outcomes as thoroughly as they do financial outcomes. We also believe this transparency helps encourage much-needed capital to be directed towards impact companies and issuers.

Q: How exactly do you measure impact?
A: To measure impact, we create custom key performance indicators (KPIs) for each company or issuer in our portfolios. The KPIs will vary depending on the security, sector or impact theme, but they must all be logical, transparent and based on reliable information, such as science-based insights from our climate research team. For example, we may measure the amount of greenhouse gas emissions avoided by recycling waste instead of sending it to landfills or the percentage of a population provided with clean water, internet access or affordable housing.

Q: How do you address the UN SDGS?
A: When the United Nations (UN) published its Sustainable Development Goals (SDGs) in late 2015, we were pleased to see how well our themes aligned. Today, between our impact equity and bond approaches, our investments address all 17 SDGs, either directly or indirectly.

For each company and issuer in our portfolios, we tag the goals we believe they align with, as well as any of the 169 underlying targets outlined by the UN. While we do not manage the portfolios to a targeted level of alignment, our high standards for inclusion result in an investment strategy that naturally supports many of the SDGs. All the companies and issuers we invest in offer what we consider to be much-needed solutions to many of the major challenges identified in the SDGs. Wellington is proud to continue supporting the UN SDGs.

Q: Which asset class is most suited to impact investing: equities or bonds?
A: Both equities and bonds provide excellent opportunities for impact investing, with large and growing opportunity sets. In fact, we believe the two asset classes provide complementary impact exposures and can be blended within a broader portfolio to create compelling synergies. Some themes are easier to access for fixed income managers, such as affordable housing bonds issued by local housing associations. Other themes, such as financial and digital inclusion, are more accessible for equity managers.

Q: What about financial returns?
A: We believe impact investing does not entail giving up return potential, and our experience to date actually points to the contrary. Both Global Impact approaches aim to deliver competitive returns for clients alongside positive social and environmental outcomes. All our impact investments must meet specific financial thresholds to be considered for inclusion in our portfolios.

In our view, many of the companies we target also benefit from structural tailwinds given their focus on products and services that seek to address some of the world’s most pressing issues. Companies that can provide effective solutions to those problems are likely to see healthy growth in their revenue and market share in the years to come.

Q: How do you bring it all together?
A: After defining the universe of potential investments that meet our impact criteria, we focus on selecting the best combination of securities to reach our financial objectives, via bottom-up research. Key to successfully building and managing portfolios, in our view, is our multi-disciplinary approach.

We regularly integrate the insights and perspectives provided by Wellington’s global teams of research professionals across industries, asset classes and investment styles. This includes close collaboration with our career credit analysts and industry specialists, who provide detailed insights at the security, industry and sector level. We also draw heavily on the expertise of our dedicated ESG research and climate research teams.

Q: How do you approach engagement?
A: We seek to enhance both the impact and the financial value of our portfolios further through active engagement with company management teams and boards.
Engagement helps us identify opportunities for companies to improve, measure and report on their impact activities. It also allows us to report more meaningful data at the issuer and portfolio level. Ultimately, engagement creates an important feedback loop and mechanism to help us deliver and measure impact.

Q: What’s so attractive about impact investing?
A: Impact investing is an exciting space where we get to help clients align their financial objectives with social and environmental aspirations. We are committed to helping investors appreciate the potential benefits of directing their equity and fixed income allocations towards solutions that help people and the planet while pursuing their investment goals.

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‘Impact investing is an exciting space where we get to help clients align their financial objectives with social and environmental aspirations’

Campe Goodman and Tara Stilwell, portfolio managers, Wellington Management

Investment risks
Capital: Investment markets are subject to economic, regulatory, market sentiment and political risks. All investors should consider the risks that may impact their capital, before investing. The value of your investment may become worth more or less than at the time of the original investment.
Concentration: Concentration of investments within securities, sectors or industries or geographical regions may impact performance.
Emerging markets: Emerging markets may be subject to custodial and political risks, and volatility. Investment in foreign currency entails exchange risks.
Equities: Investments may be volatile and may fluctuate according to market conditions, the performance of individual companies and that of the broader equity market.
Credit risk: The value of a bond may decline, or the issuer/guarantor may fail to meet payment obligations. Typically, lower-rated bonds carry a greater degree of credit risk than higher-rated bonds.
Sustainability risk: Sustainability risk can be defined as an environmental, social or governance event or condition that, if it occurs, could cause an actual or potential material negative impact on the value of an investment.
For professional and institutional investors only. This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase, shares or other securities. Investing involves risk and an investment may lose value. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed are those of the author(s), are based on available information and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients.
This material is provided by Wellington Management International Limited (WMIL), a firm authorised and regulated by the Financial Conduct Authority (FCA) in the UK.
©2021 Wellington Management Company LLP. All rights reserved.

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COP26 is
a numbers game

Tackling something as big as climate change can’t be done unless political and economic forces add up, writes Matt Crossman of Rathbones

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At the highest levels of government, feelings around hosting COP26 in Glasgow have surely fluctuated over a tumultuous 18 months. Hopes for a chance to showcase post-Brexit Britain to a watching world were set back by Covid-19, even as demands for more rapid climate action took hold.

How quickly the wildfires raging in Australia were forgotten as the pandemic took hold. The conference moved from in-person to virtual, to delayed as the full reality took hold.

By 2021, it was clear that – in person or virtual – some form of COP had to go ahead whatever happened. Under the current circumstances, I’ll probably be tuning in remotely. As if business wasn’t considered urgent enough, in August, the latest update from the UN body responsible for assessing the science on climate change issued what UN secretary general António Guterres called a “code red” for the planet.

Do the maths
Many expectations have been placed on the Glasgow summit in several key areas. Of primary significance is the need to review progress made since the Paris Agreement on long-term decarbonisation plans and efforts. The 2020 deadline agreed for these nationally determined contributions (NDCs) has been pushed back to match the pandemic-affected schedule. This review is vital given the deepening understanding of the science around climate change since 2015, and the rapid pace of action required.

In a sense, COP26 is a numbers game – do the NDCs pledged by each country curb emissions enough to keep the world below 2C of warming? Several countries and the EU have already submitted plans, with varying degrees of ambition. Since 2015, China has pledged to become climate neutral by 2060, which at least creates the opportunity for agreement on goals to reduce emissions sufficiently.

Who pays for the actions of developing nations is also highly relevant. Climate financing was a tricky enough subject even before a crippling pandemic. Under Paris, developed nations pledged to provide $100bn (£72.7bn) a year by 2020 to fund the energy transition – with good progress stalled by the pandemic.

All eyes will be on the UK to demonstrate leadership, energise negotiations and set an example for others to follow. Simply setting dates isn’t a strategy; it’s what happens in between that counts. Much more direct policy action is needed.

Good COP, bad COP
Will a good COP emerge from Glasgow this November? At the risk of making this sound like a comic-book ending, the world really needs one to come to the rescue, and it might come down to a personality like Costa Rican diplomat Christiana Figueres, head of the UNFCC at COP21 in Paris, emerging from the shadows.

We’ve always been believers in the power of responsible capitalism to make a positive difference in the world, but tackling something as big as climate change can’t be done unless political and economic forces are working together.

Matt Crossman
Stewardship director, Rathbones

‘Do the NDCs pledged by each country curb emissions enough to keep the world below 2C of warming?’

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‘It’s make or break time’

Targets, coal phase-outs and better data needed at COP26 if we are to reach net-zero goals, says Quilter Cheviot’s Gemma Woodward

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Increased ambition, coal phase-outs and a commitment to better data are what’s needed at this year’s COP summit, which could well be make or break for efforts to reach net zero by the middle of this century.

Ambition is the order of the day when it comes to setting emission reduction targets as the aim to keep 1.5C within reach is an immensely ambitious one. Countries constituting 70% of the world’s GDP have committed to the objective of net zero by 2050, but what we really need are solid and achievable 2030 targets to get us on the right path quickly.

The UK has already set a new target to reduce emissions by at least 68% by 2030 and 78% by 2035, and we need similar commitments from all countries at the summit, with clear sector-specific targets for achieving emissions reductions across the entire economy.

Coal
We’ve reached an inflection point in the history of the global economy. Coal has powered the cogs of the global economy ever since the industrial revolution and our addiction to the black stuff has existed ever since. But it’s well established that coal is the single biggest contributor to climate change and accounts for three-quarters of emissions from the electricity sector.

Clearly, this is going to be easier said than done. Governments are by no means united on the climate and will have different aims and be working to different timelines. China, for example, is currently facing an energy supply crisis so certainly won’t be in the mood to limit domestic coal use just yet. It has said it will end financing of new coal-fired power stations abroad, but has stopped short of making commitments on domestic power stations.

The UK will also be facing claims of hypocrisy for firing up coal power stations again, and diverting money from the aid budget to meet climate funding targets. We need to see specific commitments from governments on yhe phasing out of thermal coal-based electricity.

While also agreeing on getting rid of the old, there will need to be commitments on the new. Specifically, the UK government is aiming to strike a deal so that only zero-emission vehicles are on sale anywhere in the world by 2040. The UK has committed to end the sale of polluting cars by 2030, and other nations have similar commitments, but this is going to be a tall order for developing nations to commit to. Also, lest we forget, electric vehicles still need minerals, so this isn’t a simple solution.

Data
While high-level commitments are welcome and necessary, the devil is always in the detail, and this detail is where we need to see other important agreements, particularly for the financial services industry. The provision of accurate climate-related data on a global scale is going to be a fundamental challenge in the coming years.

The UK government has committed to making Task Force on Climate-Related Financial Disclosures-aligned disclosures mandatory across the economy by the middle of this decade, but the same requirements do not exist in other countries so the data is patchy, and investors do not have a complete picture. Similar agreements must be made on reporting standards and auditing standards to ensure the accuracy and reliability of climate data globally.

Gemma Woodward
Director of responsible investment,
Quilter Cheviot

‘Governments are by no means united on the climate and will have different
aims and be working to different timelines’

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