Morgan Stanley IM: You Are Not Doing ESG Investing

Morgan Stanley IM: You Are Not Doing ESG Investing
ESG

The frequent appearance of ESG in everyday conversation is a welcome development. However, it is very important to clarify what ESG is (and what it isn’t) and employ this frequently used term in its proper context.

22.04.2022 | 07:10 Uhr

Here you can find the complete article

ESG, which is shorthand for Environmental, Social and Governance factors, is having a moment. While the concept has been around for a while, references to “ESG investing, ESG funds, ESG strategies” in the media and by data providers seem to have spiked in recent months.

The term “ESG investing” is often used as a stand-in for sustainability or impact investing. It is not uncommon to hear comments along the lines of “investing in renewable energy is a key part of our ESG strategy”. In short, people assume ESG investing requires the pursuit of positive impact or doing good—for the planet or people in need. This is not the case.

In our view, ESG is not about doing good, nor is it an investment strategy in itself. ESG is simply a framework that can and, we believe, should be applied to all investment diligence processes. ESG diligence aims to identify and mitigate economic, social and governance risks that could weaken or de-rail an investment. For example, a company with inadequate environmental controls may suffer damage to its revenues, profitability, reputation and valuation should an incident occur. Investors who do not follow a process that would enable them to identify this company’s environmental shortcomings before they decide to commit their capital are likely to suffer alongside it. One does not have to be a “do-gooder” to see how weak ESG can materially affect investment returns.

When thinking about ESG, most people focus more on the “E” component, likely because the dangers are more tangible and potentially catastrophic. BP’s Deepwater Horizon oil spill is a prominent example. However, in our view, social and governance risks are equally important. Social risks occur when communities are harmed in a way that is not environment related. Wonga, a pay-day lender in the UK, saw its path to a $20bn valuation wiped out when it was accused of predatory lending practices. On the governance side, the financial press is rife with stories of managerial misconduct, from fraudulent accounting to inadequate board oversight. Theranos, for example, went from a much hyped start-up to a scandalous mess, largely in part to insufficient governance procedures.

The good news is that most investment teams consider these risks when evaluating opportunities. However, they may not bucket them into discrete ESG categories or have a formal ESG investment policy or process in place. We believe that having a strong ESG umbrella to corral these risks under in a cohesive way is valuable. A robust ESG focus embedded in all stages of the investment process, from underwriting to execution and monitoring, is fast becoming the basic requirement for any serious investment organisation. In our view, simply using an “ESG overlay” or “ESG lens”, or “giving consideration to ESG factors”, will not cut it in a sophisticated world where the asset owners and stakeholders are deeply conscious of the risks they want to avoid.

DISPLAY 1: Responsible Investment Prism

insight_youarenotdoingESGinvesting_Web Display_v1

How does this translate into action? An ESG policy is not credible if it remains just a policy. For it to be meaningful, we believe all of the investment staff need to be trained on it and such training should be refreshed on a periodic basis. We believe the tone of solid ESG processes is set at the top of organisations, and, as such, a senior member of the investment team should own the ESG process. The trained investment team should then proactively discuss ESG risks during the investment process and not address them as an afterthought. The ultimate test is whether an otherwise attractive investment is rejected because the ESG risk cannot be mitigated.

It is also important to acknowledge that ESG is not a blunt instrument. We believe it is fine to vary the level of ESG intensity from deal to deal. An investment in chemical manufacturing will require greater consideration of environmental risks than one in the software sector. The sales practices of a business focused on the public sector may require a different level of scrutiny that those of a direct-to-consumer business.

This is an evolving phenomenon and we think teams should be open to grappling with contradictions and grey areas and using a feedback loop to refine their thinking about ESG.

It is also important to place ESG in its correct context along the continuum of responsible investing.

  • ESG, as discussed, is about doing the right thing with the aim to safeguard against downside risk. It does not require a change in investment mandate such as divestment from certain sectors like extractive industries, nor does it require token efforts such as using low energy bulbs (a frequent example). ESG, in our opinion, is simply about making sure the risk of an investment failure is tightly controlled. While there may be some positive social or environmental impact from improving ESG standards, it is incidental to the investment strategy aims.
  • Sustainable investing is about seeking to achieve long-term resilience of an investment. It can be either something inherent in any long-term investor’s process or it can be an explicit strategy. This could include looking at the environmental sustainability of the production process or the viability of the supply chain. It could also mean being aligned with market trends and consumer preferences. Examples include building back up data centres in areas less prone to flooding, switching from fossil-fuel based inputs to plant-based inputs and changing stock-keeping units to cater to the growing preference for organic products. It could also be about analysing an insurance company’s liabilities arising from coastal properties or a services company adapting robotics to deal with labour shortages as the population ages. A lot of sustainability strategies will generate clear positive impact but it is not the objective of the investment strategy.
  • Impact investing, on the other hand, is very much a distinct strategy which seeks explicitly to do good—reduce CO2 emissions, save water, improve access of education and housing to deprived communities—while making sure the investment also seeks to generate compelling returns. Impact may have elements of good ESG and sustainable practices, but it is not always certain. An impact investing team, like any other investing team, needs to incorporate proper diligence procedures to seek to ensure that ESG risks are squared away. Investing in a solar farm or an affordable housing project does not automatically allay pollution risk or weak governance.

In our opinion, embedding ESG in the investment process is crucial for any investment strategy no matter where they are focused on the investment spectrum.

There is no such thing as ESG investing, but there is such a thing as employing an ESG framework to evaluate the merits and risks of an investment. We believe that, over time, as more and more teams put this structure in place, this will be known simply as “investing.” Nothing more, nothing less.


IMPORTANT INFORMATION

The information contained herein refers to research, but does not constitute an equity research report and is not from Morgan Stanley Equity Research. The views expressed herein are those of Morgan Stanley Alternative Investment Partners Private Markets (“Morgan Stanley AIP”) as of February 2022 and are subject to change at any time due to changes in market and economic conditions. The views and opinions expressed herein may differ from those of other Morgan Stanley affiliates or businesses. The views and opinions expressed herein are based on matters as they exist as of the date of preparation of this piece and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof.

These comments are not necessarily representative of the opinions and views of any other Morgan Stanley portfolio manager or of Morgan Stanley as a whole. While the information contained herein is believed to be reliable, we cannot guarantee its accuracy or completeness. The recipient should bear in mind that past performance is not indicative of future results. Keep in mind that forecasts are inherently limited and should not be relied upon as an indicator of future performance. The views expressed are subject to change based on market, economic and other conditions. They should not be construed as recommendations, but as an illustration of broader economic themes.

Information regarding expected market returns and market outlooks is based on the research, analysis, and opinions of the investment team of Morgan Stanley AIP. These conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific Morgan Stanley investment.

Certain information contained herein constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” continue” or “believe” or the negatives thereof or other variations thereon or other comparable terminology. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statements. No representation or warranty is made as to future performance or such forward-looking statements.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. There are important differences in how the strategy is carried out in each of the investment vehicles. Your financial professional will be happy to discuss with you the vehicle most appropriate for you given your investment objectives, risk tolerance and investment time horizon. This piece has been prepared solely for informational purposes and is not an offer, or a solicitation of an offer, to buy or sell any security or instrument or to participate in any trading strategy. The material contained herein has not been based on a consideration of any individual recipient circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, the recipient should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

By accepting this document, you agree that such document (including any data, analysis, conclusions or other information contained herein provided by the AIP Private Markets Team in connection herewith) may not be reproduced or otherwise shared or distributed to any other persons, in whole or in part, without the prior consent of an AIP Private Markets Team representative.

Persons considering an alternative investment should refer to the specific investment’s offering documentation, which will fully describe the specific risks and considerations associated with such investment.

Alternative investments are speculative and include a high degree of risk. Investors could lose all, or a substantial amount, of their investment. Alternative instruments are suitable only for long-term investors willing to forgo liquidity and put capital at risk for an indefinite period of time. Alternative investments are typically highly illiquid—there is no secondary market for private funds, and there may be restrictions on redemptions or the assignment or other transfer of investments in private funds. Alternative investments often utilize leverage and other speculative practices that may increase volatility and risk of loss. Financial intermediaries are required to satisfy themselves that the information in this document is suitable for any person to whom they provide this document in view of that person’s circumstances and purpose. The AP Private Markets Team shall not be liable for, and accepts no liability for, the use or misuse of this document by any such financial intermediary. If such a person considers an investment she/he should always ensure that she/he has satisfied herself/himself that she/he has been properly advised by that financial intermediary about the suitability of an investment.

This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

Alternative investments typically have higher fees and expenses than other investment vehicles, and such fees and expenses will lower returns achieved by investors. Funds of funds often have a higher fee structure than single manager funds as a result of the additional layer of fees. Alternative investment funds are often unregulated, are not subject to the same regulatory requirements as mutual funds, and are not required to provide periodic pricing or valuation information to investors. The investment strategies described in the preceding pages may not be suitable for the recipient’s specific circumstances; accordingly, you should consult your own tax, legal or other advisors, both at the outset of any transaction and on an ongoing basis, to determine such suitability.

Risks Relating to Private Equity Investments. Certain funds will typically invest in securities, instruments and assets that are not, and are not expected to become, publicly traded and therefore may require a substantial length of time to realize a return or fully liquidate. The respective general partners cannot provide assurance that they will be able to identify, choose, make or realize investments of the type targeted for their fund, or that such fund will be able to invest fully its committed capital. There can be no assurance that a fund will be able to generate returns for its investors or that returns will be commensurate with the risks of the investments within such fund’s investment objectives.

The business of identifying and structuring investments of the types contemplated by these funds is competitive and involves a high degree of uncertainty. In addition to competition from other investors, the availability of investment opportunities generally will be subject to market conditions as well as, in many cases, the prevailing regulatory or political climate. In addition, investments in infrastructure may be subject to a variety of legal risks, including environmental issues, land expropriation and other property-related claims, industrial action and legal action from special interest groups.

This is prepared for sophisticated investors who are capable of understanding the risks associated with the investments described herein and may not be appropriate for the recipient. No investment should be made without proper consideration of the risks and advice from your tax, accounting, legal or other advisors as you deem appropriate.

Morgan Stanley does not render tax advice on tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used with any taxpayer, for the purpose of avoiding penalties which may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Clients should always consult with a legal or tax advisor for information concerning their individual situation.

Diesen Beitrag teilen: