ESG and Impact Investing

UNIT 1: ESG AND IMPACT INVESTING:

INTRODUCTION AND OVERVIEW
Prof. Dr. Zacharias Sautner
Outline

✓ Introduction

✓ Terms

✓ Importance

✓ Institutional Setting
✓ Investment Strategies

✓ ESG at Institutional Investors

✓ Landscape

✓ Climate Change

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 Introduction

LECTURER
▪ Zacharias Sautner is Professor of Finance
at Frankfurt School of Finance &
Management.
▪ Previously taught at University of
Amsterdam and University of Oxford.
▪ Doing research on ESG investing and
climate finance.
▪ Published in leading international
journals such as the Journal of Finance,
Review of Financial Studies, Management
Science, or Review of Finance.
▪ Cited in media outlets, including Financial
Times, Wall Street Journal, New York
Times, and CNBC.

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Introduction

LEARNING OBJECTIVES

Understand basic terms, trends, and the landscape in ESG/impact investing.

Understand how and why ESG/impact investing affects risks and returns.

Understand how and why climate risks affect ESG/impact investing.

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Introduction

LECTURE APPROACH

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Outline

✓ Introduction

✓ Terms

✓ Importance

✓ Institutional Setting
✓ Investment Strategies

✓ ESG at Institutional Investors

✓ Landscape

✓ Climate Change

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ESG and Impact Investing

TERMS

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 Terms

ESG AND IMPACT INVESTING

ESG Investing Impact Investing
▪ Mainly about “value”. ▪ Mainly about “values”.
▪ Looks at a company's environmental, ▪ Looks at positive outcomes associated
social and governance practices, with an investment beyond financial
alongside more traditional financial outcomes (e.g., to contribute UN
measures. Sustainable Development Goals),
▪ Objective is to improve the overall ▪ Objective is to help accomplish goals
investment performance. beneficial to society or the environment.
▪ Increase financial returns or reduce ▪ May intentionally come with lower
risks. financial returns.
▪ Mostly public market investments. ▪ Mostly private market investments.

Sometimes refereed to as
responsible investing, sustainable investing, or
corporate social responsibility (CSR) investing
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 Terms

ESG AND IMPACT INVESTING: EXAMPLE FROM GOLDMAN SACHS

▪ “With increasing interest and activity in Environmental, Social, and Governance (ESG)
and impact investing, clients are seeking ways to enhance the ESG alignment of their
investments and have a positive impact while generating financial return.”
▪ “At Goldman Sachs Asset Management (GSAM), we provide holistic solutions that are
designed to combine the positive impacts of ESG and impact investing with the rigor and
risk-return standards of investment management.”
▪ “ESG and impact investing are, first and foremost, investing. They require the same
discipline and rigor as any investment practice. We approach this strategy on an
investment basis, not a philosophical one, and target institutional grade, market rate of
return investments.”

Source: Goldman Sachs Asset Management

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Terms

ESG AND IMPACT INVESTING: EXAMPLE FROM GOLDMAN SACHS

Source: Goldman Sachs Asset Management

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Terms

ESG INVESTING TOPICS: EXAMPLES

Source: Anevis Solutions

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 Terms

ORIGIN OF THE TERM “ESG”

▪ Publication of report “Who Cares Wins” by
the UN Global Compact in 2006.
▪ “This report is the result of a joint initiative
of financial institutions which were invited
by United Nations Secretary-General Kofi
Annan to develop guidelines and
recommendations on how to better
integrate environmental, social and
corporate governance issues in asset
management, securities brokerage services
and associated research functions.”

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Terms

IMPACT INVESTING TOPICS: EXAMPLES

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Terms

IMPACT INVESTING TOPICS: EXAMPLES

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Message from Frankfurt School

Food for Your company has decided to allocate some

Thought:
resources to either ESG or Impact Investing.
You were asked to explain the differences
between the two types of investments to the
board. How would you explain them?

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Message from Frankfurt School

Here are some possible answers:

ESG investing aims to achieve better investment
performance by considering environmental, social,
and governance issues. Better investment
performance can be achieved by reducing risks or
increasing returns.
Impact investing aims to achieve positive
environmental or social outcomes through
investment decisions, even if this comes with
lower returns.

In general, there are several, and at times

competing definitions of ESG and Impact Investing.
We feel it is very useful to be aware of the often
consufing terminology, so we will spend quite a lot
of time on this in Unit 2.

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Outline

✓ Introduction

✓ Terms

✓ Importance

✓ Institutional Setting
✓ Investment Strategies

✓ ESG at Institutional Investors

✓ Landscape

✓ Climate Change

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ESG and Impact Investing

IMPORTANCE

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 100

10
20
30
60
70
80
90

40
50

0
2010-01
2010-05
2010-09
Importance

2011-01
2011-05
2011-09
2012-01
2012-05
2012-09
2013-01
2013-05
2013-09
2014-01
2014-05
2014-09
2015-01
2015-05
2015-09
2016-01
2016-05
2016-09
2017-01
2017-05
2017-09
2018-01
2018-05
2018-09
2019-01
2019-05
2019-09
2020-01
2020-05
GROWTH IN GOOGLE SEARCHES FOR TERM “ESG”, WORLDWIDE

2020-09
Source: Google Trends

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Importance

GROWTH IN PRI SIGNATORIES

Source: PRI

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Importance

GROWTH IN ESG FUND FLOWS, DESPITE COVID-19

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Importance

ENORMOUS GROWTH IN ESG FUND ASSETS, OVERALL

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 Importance

BLACKROCK LETTERS TO CEOS

▪ Largest asset manager in the world, with USD 7.8 trillion AuM in 2020.
▪ Letters from Larry Fink, Chairman and CEO, to CEOs of their portfolio companies.
▪ 2016: “Over the long-term, environmental, social and governance (ESG) issues -
ranging from climate change to diversity to board effectiveness - have real and
quantifiable financial impacts.”
▪ 2017: “Environmental, Social and Governance (ESG) factors relevant to a company's
business can provide essential insights into management effectiveness and thus a
company's long-term prospects.”
▪ 2018: “As a fiduciary, BlackRock engages with companies to drive the sustainable,
long-term growth that our clients need to meet their goals…” “Society is demanding
that companies, both public and private, serve a social purpose. To prosper over
time, every company must not only deliver financial performance, but also show
how it makes a positive contribution to society.”

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 Importance

ESG AND MUTUAL FUND FLOWS

▪ Study by Hartzmark and Sussman (2019).
▪ Analysis of 20,000 mutual funds – USD $8 trillion; from March 2016.
▪ Morningstar ESG ratings (“globes”) of mutual funds based on weighted average of
portfolio firm’s scores on ESG issues (ESG ratings from Sustainalytics).

Percentile rank Raw Score Descriptive Rank Globes measure

Highest 10% 5 High
Next 22.5% 4 Above Average
Next 35% 3 Average
Next 22.5% 2 Below Average
Lowest 10% 1 Low

Source: Hartzmark and Sussman, 2019, Do Investors Value Sustainability? A Natural Experiment
Examining Ranking and Fund Flows, Journal of Finance 74, 2789-2837
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Importance

ESG AND MUTUAL FUND FLOWS

Source: Hartzmark and Sussman, 2019, Do Investors Value Sustainability? A Natural Experiment
Examining Ranking and Fund Flows, Journal of Finance 74, 2789-2837
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Message from Frankfurt School

Food for
Thought:
The investment industry has witnessed a
massive trend towards ESG Investing. A family
member asks you why. Can you explain to them
what the key drivers of this trend may have
been?
Message from Frankfurt School

Here are some possible answers:

• Greater awareness of global risks
such as climate change.
• A recognition that ESG investing does
not equate to forfeiting returns, but
instead is associated with better risk-
return relationships.
• Regulatory requirements.
• Demographic shifts to millennials and
women.
Outline

✓ Introduction

✓ Terms

✓ Importance

✓ Institutional Setting
✓ Investment Strategies

✓ ESG at Institutional Investors

✓ Landscape

✓ Climate Change

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ESG and Impact Investing

INVESTMENT STRATEGIES

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Investment Strategies

ESG AND IMPACT INVESTMENT STRATEGIES

▪ Negative screening ▪ Differences across ESG
▪ Exclusions (Divestment) ▪ Environmental issues
▪ Norm-based screening ▪ Labour and human rights issues
▪ Positive screening ▪ Business practices
▪ Sustainability-themed ▪ Governance issues
▪ Best-in-class
▪ ESG integration
▪ Engagement & voting (shareholder
activism)

▪ Impact investing

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Investment Strategies

ESG AND IMPACT INVESTMENT STRATEGIES

Positive
screening

Negative
screening

Source: Banking Hub

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Investment Strategies

EXAMPLES OF ESG INVESTING

▪ TIAA invests on behalf of over 5 ▪ NBIM invests on behalf of the Norwegian

million active and retired employees people (oil fund).
▪ > USD 1.2 trillion in AUM (December ▪ > USD 1.25 trillion in AUM (December
2020) 2020)

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Investment Strategies

TIAA AND ESG INVESTING: PHILOSOPHY

“TIAA’s responsible investment capabilities are designed to seek competitive

returns while promoting broad economic development, positive social
outcomes and a healthier environment.”
“TIAA is actively engaged across the four key pillars of responsible investment.”

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 Investment Strategies

TIAA AND ESG INVESTING: FOUR KEY PILLARS

▪ ESG integration
▪ Consider environmental, social & governance (ESG) factors in investment research
and decisions.
▪ ESG-focused funds
▪ Explicitly include ESG criteria in the investment decision-making approach.
▪ Active ownership
▪ Use their influence to improve issuer’s ESG management, performance and
disclosure.
▪ Impact investing
▪ Make investments with a goal of financial return and measurable social or
environmental outcomes.

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 Investment Strategies

NBIM AND ESG INVESTING: PHILOSOPHY

“The Ministry considers sound financial return over time to be conditional upon
sustainable economic, environmental and social development, as well as
well-functioning, legitimate and efficient markets.”
“The Bank shall integrate considerations of good corporate governance and
environmental and social issues in its investment activities, in line with
internationally-recognised principles for responsible investment. Integration of
these considerations shall occur in respect of the Fund’s investment strategy
and role as financial manager.”

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 Investment Strategies

NBIM AND ESG INVESTING: EXCLUDED STOCKS

PRODUCTION OF COAL OR COAL- PRODUCTION OF TOBACCO SERIOUS VIOLATIONS OF THE RIGHTS

BASED ENERGY 21 companies OF INDIVIDUALS IN SITUATIONS OF
> 70 companies WAR OR CONFLICT, Africa Israel
PRODUCTION OF WEAPONS THAT Investments, Shikun & Binui
ACTIONS OR OMISSIONS THAT
THROUGH THEIR NORMAL USE MAY CONSTITUTE AN UNACCEPTABLE RISK OTHER PARTICULARLY SERIOUS
VIOLATE FUNDAMENTAL OF THE FUND CONTRIBUTING TO: VIOLATIONS OF FUNDAMENTAL
HUMANITARIAN PRINCIPLES ETHICAL NORMS,
PRODUCTION OF CLUSTER SERIOUS OR SYSTEMATIC HUMAN 5 companies
MUNITIONS RIGHTS VIOLATIONS COMPANIES PLACED UNDER
4 companies including Textron, Atal, Zuari Agro Chemicals, Wal-Mart OBSERVATION
and General Dynamics Stores, Wal-Mart de Mexico SA CV Astra Intl. Tbk PT because of the risk
SEVERE ENVIRONMENTAL DAMAGES of severe environmental damage.
PRODUCTION OF NUCLEAR ARMS 18 companies including Duke Energy, Petro China and Petroleo Brasileiro
16 companies including Lockheed Barrick Gold, Rio Tinto, Freeport SA because of the risk of severe
Martin, Northrop Grumman, McMoRan Copper & Gold corruption
Honeywell, Airbus Group, Boeing GROSS CORRUPTION Other companies
ZTE (2016)

As of 2018

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Investment Strategies

IMPACT INVESTING: EXPECTED RETURN AND IMPACT

Global Impact Investing Network (GIIN) definition of impact investing:
Investments made with the intention to generate positive, measurable social and
environmental impact alongside a financial return.

Source: Bridgespan
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Message from Frankfurt School

Food for We know that this was probably a bit fast, and
Thought: perhaps even a bit abstract. But it is important
to understand the different approaches to ESG
and impact investment strategies.
More details will follow in Unit 4.
Outline

✓ Introduction

✓ Terms

✓ Importance

✓ Institutional Setting
✓ Investment Strategies

✓ ESG at Institutional Investors

✓ Landscape

✓ Climate Change

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ESG and Impact Investing

ESG AT INSTITUTIONAL INVESTORS

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ESG at Institutional Investors

CALLAN INSTITUTE SURVEY ON ESG

Source: Callan Institute Survey on ESG 2020

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ESG at Institutional Investors

HOW ARE INVESTORS INCORPORATING ESG? MANAGER SELECTION

Source: Callan Institute Survey on ESG 2020

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ESG at Institutional Investors

HOW ARE INVESTORS INCORPORATING ESG? INVESTMENT PROCESS

Source: Callan Institute Survey on ESG 2020

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ESG at Institutional Investors

REASONS FOR INCORPORATING ESG FACTORS

Source: Callan Institute Survey on ESG 2020

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ESG at Institutional Investors

REASONS FOR NOT INCORPORATING ESG FACTORS

Source: Callan Institute Survey on ESG 2020

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Outline

✓ Introduction

✓ Terms

✓ Importance

✓ Institutional Setting
✓ Investment Strategies

✓ ESG at Institutional Investors

✓ Landscape

✓ Climate Change

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ESG and Impact Investing

LANDSCAPE

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 Landscape

KEY PLAYERS, BEYOND INDIVIDUAL INSTITUTIONAL INVESTORS

▪ ESG investor coalitions
▪ Financial data providers
▪ ESG rating firms
▪ Companies
▪ Proxy voting advisors
▪ Regulators

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 Landscape

ESG INVESTOR COALITIONS

▪ ICCR
▪ PRI
▪ CDP
▪ TCFD
▪ IIGCC
▪ Investor Network on Climate Risks
▪ Climate Action 100+
▪ Ceres
▪ Global Investor Coalition on Climate Change
▪ Investor Group on Climate Change

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 Landscape

ESG INVESTOR COALITIONS: PRI

▪ Launched in April 2006, following an initiative by the UN, 3,000+ signatories.
▪ “As institutional investors, we have a duty to act in the best long-term interests of our
beneficiaries. […] we believe that environmental, social, and governance (ESG) issues can
affect the performance of investment portfolios... […] These Principles may better align
investors with broader objectives of society.”
▪ 6 Principles
▪ Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
▪ Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and
practices.
▪ Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
▪ Principle 4: We will promote acceptance and implementation of the Principles within the investment
industry.
▪ Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
▪ Principle 6: We will each report on our activities and progress towards implementing the Principles.

Source: PRI

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 Landscape

ESG INVESTOR COALITIONS: CLIMATE ACTION 100+

▪ Climate Action 100+ is an investor-led initiative with the goal that the world’s largest
corporate greenhouse gas emitters take action on climate change.
▪ Focus on the world’s largest carbon emitters (167 firms in 2020, responsible for about 80%
of industrial emissions).
▪ Supported by 500+ investors, representing USD 50+ trillion in assets, signatories include
Blackrock and StateStreet.
▪ As signatories, investors commit to engagement with companies, in seeking to ensure
they:
▪ Take action to reduce greenhouse gas emissions across the value chain in line with the overarching
goals of the Paris Agreement;
▪ Implement a strong governance framework which clearly articulates the board’s accountability and
oversight of climate change risks and opportunities; and
▪ Provide enhanced corporate disclosure in line with the recommendations of the Task Force on Climate-
related Financial Disclosures (TCFD).

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 Landscape

ESG INVESTOR COALITIONS: CDP

▪ Founded in 2000, CDP (formerly known as the Carbon Disclosure Project) collects on
behalf of investors representing over $100 trillion in assets under management climate-
related information through a firm questionnaire.
▪ Carbon emissions, climate risk management, governance, risks and opportunities.
▪ Carbon emissions data also used for many ESG ratings.
▪ Recently also surveys on water security and forests.
▪ Over 9,600 companies reported through CDP on climate change, water security and
forests.

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Landscape

FINANCIAL DATA PROVIDERS: EXAMPLE BLOOMBERG TERMINAL

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Landscape

ESG RATING FIRMS: OVERVIEW

KLD

ASSET4

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Landscape

ESG RATING FIRMS: EXAMPLE FROM REFINITIV ESG RATINGS

Source: Refinitiv, April 2020

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Landscape

ESG RATING FIRMS: USE BY INSTITUTIONAL INVESTORS

Source: Rate the Raters 2020: Investor Survey and Interview Results

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Landscape

ESG RATING FIRMS: INFORMATION SOURCE FOR ESG PERFORMANCE

Source: Rate the Raters 2020: Investor Survey and Interview Results

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Landscape

ESG RATINGS FIRMS: REASONS FOR USAGE

Source: Rate the Raters 2020: Investor Survey and Interview Results

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Landscape

ESG RATING FIRMS: RATING QUALITY

Source: Rate the Raters 2020: Investor Survey and Interview Results

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Landscape

ESG RATING FIRMS: DISAGREEMENT, CORRELATIONS ACROSS RATERS

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Landscape

ESG RATING FIRMS: DISAGREEMENT, EXAMPLES

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 Landscape

ESG RATING FIRMS: DATA REWRITING

▪ Study by Berg, Fabisik, and Sautner (2020).
▪ Document widespread changes to the historical ESG scores of Thomson Reuters Refinitiv
ESG, a key rating provider.
▪ Observe large ESG rating changes for identical firm-years across two ESG data downloads
in September 2018 and September 2020.
▪ Depending on whether the original or rewritten data are used, firm rankings and
frequently used classifications of firms into ESG quantiles change.
▪ These changes affect tests that relate ESG ratings to firm performance or stock returns.
▪ Important implications for backtesting and research.

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Landscape

ESG RATING FIRMS: OVERLAPS BETWEEN THE INITIAL AND

REWRITTEN REFINITIV ESG DATA (S&P 1500)

Only 68.5% of S&P

1500 firms are ranked
in the Top 10% in both
data downloads (for
identical periods of
time)

Source: Berg, Fabisik, and Sautner, 2020, Rewriting History II: The (Un)Predictable Past of
ESG Ratings, Working Paper, Available at https://ssrn.com/abstract=3722087
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Landscape

ESG RATING FIRMS: DATA REWRITING, CONSEQUENCES

Source: Berg, Fabisik, and Sautner, 2020, Rewriting History II: The (Un)Predictable Past of
ESG Ratings, Working Paper, Available at https://ssrn.com/abstract=3722087
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Landscape

COMPANIES: MOST SUSTAINABLE COMPANIES IN THE WORLD

Global 100 ranks the most sustainable firms in the world based on ESG factors.

Source: Global 100 Ranking, 2020

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Landscape

COMPANIES: 10 MOST SUSTAINABLE COMPANIES IN THE WORLD

Source: Global 100 Ranking, 2020

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Landscape

COMPANIES: EXAMPLE OF ESG PERFORMANCE OF NORVATIS

Source: Novartis

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 Landscape

PROXY VOTING ADVISORS

▪ Provide a service to address many institutional investor’s regulatory requirement to vote
shares in portfolio companies in the best interest of their final beneficiaries.
▪ Make voting recommendations on ESG agenda items at shareholder meetings.
▪ Two companies dominate the market for proxy voting advice.
▪ ISS, the market leader, was founded in 1985 bought in 2020 by Deutsche Börse,
owned previously by private equity firms, MSCI, and RiskMetrics (which was bought
by MSCI).
▪ Glass Lewis, is a portfolio company of the Ontario Teachers’ Pension Plan Board and
the Alberta Investment Management Corp. and was founded in 2003.
▪ Proxy voting advisors seem to affect a significant amount of votes as many institutions
investors seem to follow their recommendations
▪ Malenko and Shen (2016) find that ISS moves 25% of votes on say-on-pay.

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Landscape

REGULATORS: UPCOMING ESG REGULATION IN THE EU

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Message from Frankfurt School

Food for Rating agencies and the way in which they

Thought:
assess ESG criteria are gaining more clout, and
becoming more relevant. What do you consider
the key challenges when it comes to using ESG
ratings?
Message from Frankfurt School

Here are some possible answers:

• Many providers.
• Often big disagreement across providers.
• ESG ratings are sometimes rewritten ex-post.
• Lack of transparency how ESG ratings are constructed.
• ESG ratings may not be updated instantaneously.
• ESG rating firms may not have access to all material
information, as ESG reporting is still often not mandatory.

More details about the differences in the rating approaches

the different agencies have adapted, and how to best
understand and make them work for you will follow in Unit 6.
Outline

✓ Introduction

✓ Terms

✓ Importance

✓ Institutional Setting
✓ Investment Strategies

✓ ESG at Institutional Investors

✓ Landscape

✓ Climate Change

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ESG and Impact Investing

CLIMATE CHANGE

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Climate Change

CARBON EMISSIONS AND GLOBAL WARMING

Source: https://earthobservatory.nasa.gov/features/CarbonCycle/page5.php
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Climate Change

PARIS AGREEMENT 2015 (COP 21)

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 Climate Change

WHY RELEVANT FOR ESG AND IMPACT INVESTING?

▪ Possibly huge effects on financial markets.
▪ To meet the 2 °C target, huge capital reallocations needed.
▪ 80% of coal reserves should remain unused from 2010 to 2050.
▪ 33% of oil reserves.
▪ 50% of gas reserves.
▪ Climate change will have a major impact on financial markets.
▪ Financial markets will have a major impact on climate change.

Source: McGlade, Christophe, and Paul Ekins, 2015, The geographical distribution of fossil
fuels unused when limiting global warming to 2 °C, Nature 517, 187–190.

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