By Hamlin Lovell, NordicInvestor
Hamlin Lowell interviewed Jentzen & Partners co-founder and Managing Partner, Mads Jensen, to gather some insights into how “tier 2” institutions in Denmark are approaching ESG. Jentzen was founded in 2012 by a team of five who had previously worked together at Danske Asset Management and elsewhere. Jentzen advises professional investors at smaller and medium sized asset owners on longer term strategic asset allocation, including manager selection and developing investment policies including governance frameworks and increasingly ESG.
Jentzen’s client base, including charities, private endowments, corporate foundations and special entities, were not the first movers on ESG, but they are rapidly evolving from early exclusion lists onto next generation ESG thinking around engagement and ESG integration. This could lead to divestments from some asset managers and asset classes.
E, S and G are all relevant. “Environmental concerns around climate and carbon are becoming a higher priority, but there is a danger that majoring on climate leads investors to overlook governance and social. Governance has always been a focus for any kind of asset selection, because well run companies tend to provide better returns. The social side is more intangible and probably needs a taxonomy, such as the upcoming EU taxonomy expansion to include social,” expects Jensen.
The approach varies with different strategies and asset classes. “ESG can be difficult to apply to CTA strategies, but it can have most influence in primary capital markets that reward or punish companies in terms of cost of capital. Private equity and private debt managers are now paying a lot more attention to ESG. As sole or majority owners, with board presence, they are in a unique position to have more impact than investors in listed companies,” argues Jensen.
More broadly, Jensen shares the general Nordic preference for active over passive management, and this is partly due to ESG: “ESG integration requires active management because markets are not efficiently pricing these risks, and active managers have a chance to show their relevance,” opines Jensen.
ESG, style and factor exposures
But Jensen does not share the common perception and marketing assertion that ESG in itself leads to outperformance. He takes a more agnostic view. The outperformance of ESG equities over some time periods, such as 2020, can be explained by factor and sector exposures: firms with higher ESG scores tend to be “growth” names, and overweighting technology while underweighting oil was clearly helpful in 2020. In late 2021 and early 2022, higher interest rates have started to reduce valuations for growth stocks, and some commodity producers are super-profitable, which has led many ESG equity strategies to underperform, but again this is not a full market cycle. “On balance we do not think there are enough datapoints to determine whether ESG outperforms. Over very long periods, we are not sure if excluding sectors makes much difference. A Credit Suisse study of excluding individual sectors concluded that it made very little difference over the past 100 years,” points out Jensen.
Exclusions and benchmarks
In any case there is little consensus over which sectors and companies to exclude. Jensen sees a variety of developing approaches around exclusions: ”exclusions two years ago were standard UNPRI, UN Global Compact areas such as controversial weapons and human rights. They then moved onto more granular and values-based areas like tobacco, alcohol and thermal coal. Even coal is becoming more nuanced with tolerance for different thresholds of exposure and potential to invest in some companies that show evidence of transition. Exclusions such as gambling and pornography are more faith-based and often Swedish,” he finds.
Adoption of ESG benchmarks has been slow but is probably a logical conclusion of exclusions: “clients should probably find ESG benchmarks that match their own exclusions policy to avoid noise and unintended biases, but we have not seen clients adopt these benchmarks yet,” observes Jensen.
Data subjectivity and audits
The jungle of disparate ESG data is a challenge with multiple ESG metrics that may lead to different answers. “Smaller asset owners do not necessarily have a dedicated ESG team in house and may not even have a single person exclusively devoted to ESG, so they need to rely on external providers,” says Jensen.
Subjectivity is a key challenge not only for data but also for defining ESG itself. “If you ask 1,000 clients to define a sustainable, ethical or green fund, you may get 1,000 different responses. This is a noisy process that will certainly create more work for compliance officers and lawyers, and possibly also auditors. ESG data is not yet part of audited financial statements, but it could be added to them,” he expects.
EU SFDR at an early stage
The EU rules could provide some clarity, but investors are still waiting for details and technical standards. “The fear is of another bureaucratic nightmare that will require much resources to be spent on data gathering, cleaning and reporting, without much added value to investors,” says Jensen.
The SFDR cannot be ignored in Europe: “There is definitely demand for strategies reporting under SFDR 8 and 9. Some clients already avoid SFDR 6 funds while others are likely to rule them out in a few years, but temporarily allow some article 6 funds that include transition,” Jensen sees. It is also possible that article 6 funds may remain widely offered due to some uncertainty over the criteria for an article 6 or 8 fund. “Some asset managers would rather “gold-plate” an article 6 fund than “greenwash” an article 8 fund and risk misclassifying it,” finds Jensen.
Thematic strategies and Impact Investing
The EU taxonomy may lead to impact funds which can be focused on thematics including certain sectors and sub-sectors. Since Jentzen is providing broad-based asset allocation advice, it would be too granular to recommend thematic funds in areas such as water or green bonds. “We would view these as gambling or speculation. We do however have one client heavily invested in timber, which provides a form of natural carbon capture,” says Jensen.
Timber clearly has a positive impact, but more broadly impact investing is a grey area where there are different opinions over whether it is consistent with maximizing risk adjusted returns. Jensen is for now rather skeptical. “Many investors would prefer to pursue impact through philanthropy, separate from investing. Surveys show most investors favour financial returns over impact,” says Jensen.
