@Royal London Asset Management.
Insurers have been subjected to increasing expectations and pressures around managing climate-related risks throughout their businesses in recent years, and these pressures show no signs of abating – particularly around the assets they choose to invest in. However, while most have turned their attention towards a more environmentally-aware asset strategy, there is no one accepted version of what having a ‘green’ investment allocation actually means. While ‘50 shades of green’ is perhaps an exaggeration, there are a range of possible ‘green’ approaches available to insurers who recognise that to ‘do nothing’ is not an option.
The sustainability spectrum below categorises these core investment strategies. For example, ‘responsible’ investing considers integrating environmental, social and governance (ESG) principles as part of the security selection process, but without explicitly excluding investments based only on environmental criteria. A ‘sustainable’ investment approach goes a step further, combining ESG integration with positive screening of companies providing goods and services expected to provide a longer-term environmental or societal benefit, or considered ESG leaders in their field. Lastly, an ‘impact driven’ investment approach focuses on companies looking to achieve specific objectives (such as wind farms and solar power companies accelerating the transition from fossil fuels).
Source: RLAM. For illustrative purposes only.
As well as considering the environmental outcomes associated with each of these strategies, it is important to understand the potential impact on returns, particularly given the ongoing ultra-low yield environment.
For example, while incorporating ESG criteria and having a more sustainable investment approach is expected to improve risk-adjusted returns, returns could potentially be compromised through an Impact Driven strategy offering less diversification and where the primary objective is the ESG outcome, rather that investment returns. Of course, it is worth noting that an insurer may utilise different approaches across different parts of their portfolio – for example having a Responsible approach for all assets apart from a smaller allocation to Impact Driven investments.
At a more detailed implementation level, while the increased focus on issuers demonstrating green credentials is a big step forwards in the industry, it is critical that investors and their asset managers do their homework and do not blindly rely on the green label. Given the very large and ever-increasing amount of capital looking for environmentally focused themes and activities, there is a real risk of investors being impacted by ‘Greenwashing’ and the so called ‘Greenium’ (Green premium), which skews the market pricing for certain investments. A thorough evaluation of a company’s activities, future plans and intention to improve business practices around environmental policies is necessary.
The insurance industry has a valuable role to play in supporting the necessary transition to a low carbon economy, but the implementation of this via the ‘greening’ of investment portfolios requires careful consideration. With many different shades of green available within an investment approach, insurers should first determine how much of a focus should be on prioritising specific green investments (relative to more broadly integrating climate risk within investment portfolio decisions) and how this balances against return expectations.
The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and are not investment advice.
For professional clients only, not suitable for retail investors.
This is a financial promotion and is not investment advice.
Issued in July 2021 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.
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