Sustainable investing: Where are we today?

Has the role of sustainable investing changed?

Welcome & Intros

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Welcome & Intros

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COMING OCTOBER 2022: INVESTING FOR THE FUTURE – KEY INVESTMENT TRENDS FOR 2023 AND BEYOND

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Income is the outcome

The importance of sustainable investing has grown further during the pandemic and with investors’ increased focus on environmental, social and governance factors. But is the role of these investments changing when investors are confronted with critical situations, such as the war between Russia and Ukraine? In this panel, three experts discuss areas of interest in the sustainable investing sphere which have experienced transformation – including companies that changed their business models to become bellwethers of their industries, and the rising scepticism that has emerged as a result of frothy ESG labelling. Featuring: Mary Jane McQuillen, head of ESG investment and portfolio manager at ClearBridge Investments; Craig Cameron, portfolio manager at Templeton Global Equity Group, and; Andrew Ness, portfolio manager and deputy director of research at Franklin Templeton Emerging Markets Equity.

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sustainable investing: where are we today?

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Mary Jane McQuillen

Head of ESG investment and portfolio manager at ClearBridge Investments

Craig Cameron

Portfolio manager at Templeton Global Equity Group

Andrew Ness

Portfolio manager and deputy director of research at Franklin Templeton Emerging Markets Equity

Green investing has cast a golden shadow over the investment landscape in recent times, but critics suggest it’s losing its lustre. ESG funds have posted heavy losses in recent months¹, and concerns over greenwashing remain². Just a few days ago, HSBC’s responsible investing lead Stuart Kirk was forced to quit after downplaying the importance of climate change, highlighting the ongoing discord that surrounds this topic. The topic of our latest panel session with Franklin Templeton was spectacularly timely. We probed the issue of sustainable investing with the help of three experts: Mary Jane McQuillen – head of ESG at ClearBridge in New York – and Andrew Ness and Craig Cameron – both from Franklin Templeton’s Edinburgh office. As well as analysing the most salient trends, we looked at how investors and asset managers can ride the current headwinds and identify value in an area that has long been marked by hype and misunderstanding. Our panellists were in no doubt that the last few months have been incredibly challenging. Investment in areas such as renewable energy is short of that required, and although investor interest has continued to increase during Covid-19 , the pandemic and the resulting economic turmoil has forced a fundamental rethink in a sector that has been booming for years. Cameron suggested that ‘gravity has returned to the market’, adding that ‘two of the top performing sectors right now are energy and defence, and those are areas that climate strategies tend to avoid. We’ve also got a lot of concern around supply chain issues, rising inflation and of course, pressure on long-term growth stocks. ‘Climate change [investment], in particular, has been hit hard because the space leans towards those unprofitable growers and companies that are susceptible to supply chain issues.’ However, alongside the uncertainty, there are plenty of grounds for optimism. For one, investment opportunities continue to widen. Andrew Ness, who specialised in emerging markets for over 25 years , highlighted this point, saying what he is currently witnessing is a capital markets boom across his asset class with lots of new investment opportunities across a range of countries. Beyond these immediate opportunities, there is the sense that ESG and sustainability considerations are becoming ever more entrenched in mainstream society. Renewable energy investment continues to surge around the world [the Ukraine crisis has only accentuated its importance ], and, while President Biden’s climate targets are facing pushback in the US , other countries like Australia are ramping up their commitments to the Paris Climate Agreement. As an avalanche of opinion polls from northern England to rural New Zealand make clear , people care more about climate and sustainability than ever. The environment is no longer a niche issue but a pertinent part of our daily lives. ‘If we look at sustainable development [and] sustainable investment goals, it’s very much about a long-term, multi-stakeholder approach to value creation’, Ness added. ‘No longer just a shareholder obsession [but] a much broader societal focus on very much looking at real-world outcomes.’ This presents challenges for investors, to be sure. Sustainability can no longer be ring-fenced to a specialist department; every team must be conversant with ESG and green issues. The other reason is both investors and asset managers have the chance to be on the right side of history. As Mary Jane McQuillen noted, ‘through innovation and capital, we can actually effectuate a lot of important change.’ But how do investors maximise the potential of this moment – and how to identify companies that will make a lasting difference to tomorrow’s norms? Firstly, a huge amount of research is required. The panel noted the importance of ‘boots on the ground’ – local teams that can identify trends in their territories and build relationships with both business leaders and policymakers. McQuillen said it is imperative that investors ‘look under the hood and see the quality of the management team, [their] performance track record, history and experience – specifically investing in sustainable approaches. The number of managers that have that experience is relatively small, but the number of products is relatively high and growing quite quickly.’ Another key point referenced by the panel was the need for positive dialogue with portfolio companies; investors must push companies to keep improving the way they treat their employees, their suppliers and the environment. Ness revealed that Franklin Templeton has developed its own proprietary ESG framework which provides a framework for clear, target-driven dialogue with companies. By holding the right conversations, real results can be procured. McQuillen told the panel that after more than a six-year push from her colleagues, a ClearBridge portfolio company was able to reduce it water usage by almost 100%, creating a reputation boost that curbed employee turnover. ‘I think the incentives have to be there sometimes,’ she said. ‘They shouldn’t always have to be there, but if you’re able to express them in a clear, rational way, I think they will also be very receptive.’ As well as being proactive with companies, asset managers have to be pragmatic with clients. Sustainability is still an evolving area with widespread discrepancy over even its most basic definitions. Both Ness and Cameron referred to the ‘grey zone’, suggesting that companies’ approach to issues such as energy usage must be framed by content and reasonable expectations. With this in mind, Ness suggested it is important to acknowledge the ‘messiness’ in ESG – particularly in emerging markets, an area he specialises in. ‘The more that we can be honest with the market and honest with our clients about the challenge of doing this without promising the world, then I think it becomes, perhaps, a much more credible movement.’ But while asset managers must remain cognisant of the challenges of ESG and sustainability – and try not to force clients to transform overnight – they can take heart from the underlying trends. The world is only going one way, and that’s towards a greener future - so the business case for sustainability will continue to get stronger. ‘I often think of ESG analysis as essentially just good business analysis,’ Cameron said. ‘Ultimately, it’s factors that benefit companies over the long-term that we’re talking about here. ‘Environmental, social and governance typically are good indicators of long-term performance - and businesses that will beat the competition.’

Sustainable Investing: How to turn global crisis into opportunity

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sustainable investing: where are we today?

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English subtitles

French subtitles

Italian subtitles

German subtitles

Mary Jane McQuillen

Head of ESG investment and portfolio manager at ClearBridge Investments

Craig Cameron

Portfolio manager at Templeton Global Equity Group

Andrew Ness

Portfolio manager and deputy director of research at Franklin Templeton Emerging Markets Equity

Green investing has cast a golden shadow over the investment landscape in recent times, but critics suggest it’s losing its lustre. Concerns over greenwashing have increased sharply while the number of sustainable funds hitting the market soars. Just a few days ago, HSBC’s responsible investing lead Stuart Kirk was forced to quit after downplaying the importance of climate change, highlighting the ongoing discord that surrounds this topic. The topic of our latest panel session with Franklin Templeton was spectacularly timely. We probed the issue of sustainable investing with the help of three experts: Mary Jane McQuillen – Head of ESG investment and Portfolio Manager at ClearBridge Investments in New York, Andrew Ness, Portfolio Manager, Deputy Director of Research at Franklin Templeton Emerging Markets Equity and Craig Cameron, Portfolio Manager at Templeton Global Equity Group – both located in Edinburgh. As well as analysing the most salient trends, we looked at how investors and asset managers can ride the current headwinds and identify value in an area that has long been marked by hype and misunderstanding. Our panellists were in no doubt that the last few months have been incredibly challenging. Investment in areas such as renewable energy is short of what is required, and although investor interest has continued to increase during Covid-19¹ the pandemic and the resulting economic turmoil has forced a fundamental rethink in a sector that has been booming for years. Cameron suggested that ‘gravity has returned to the market’, adding that ‘two of the top performing sectors right now² are energy and defence, and those are areas that climate strategies tend to avoid. We’ve also got a lot of concern around supply chain issues, rising inflation and of course, pressure on long-term growth stocks.’ ‘Climate change [investment], in particular, has been hit hard because the space leans towards those unprofitable growers and companies that are susceptible to supply chain issues.’ However, alongside the uncertainty, there are plenty of grounds for optimism. For one, investment opportunities continue to widen. Andrew Ness, who has been specialising in emerging markets for over 25 years, highlighted this point, saying what he is currently³ witnessing is a capital markets boom across his asset class with lots of new investment opportunities across a range of countries. Mary Jane McQuillen, with over 25 years of sustainable investing experience, said it is imperative that investors ‘look under the hood and see the quality of the management team, [their] performance track record, history and experience – specifically investing in sustainable approaches. The number of managers that have that experience is relatively small, but the number of products is relatively high and growing quite quickly.’ Beyond these immediate opportunities, there is the sense that sustainable investing considerations are becoming ever more entrenched in mainstream society. Renewable energy investment continues to surge around the world⁴ [the Ukraine crisis has only accentuated its importance⁵], and, while President Biden’s climate targets are facing pushback in the US⁶, other countries like Australia are ramping up their commitments to the Paris Climate Agreement. As an avalanche of opinion polls from northern England⁷ to rural New Zealand make clear⁸, people care more about climate and sustainability than ever. The environment is no longer a niche issue but a pertinent part of our daily lives. ‘If we look at sustainable development [and] sustainable investment goals, it’s very much about a long-term, multi-stakeholder approach to value creation’, Ness added. ‘No longer just a shareholder obsession [but] a much broader societal focus on very much looking at real-world outcomes. ‘This presents challenges for investors, to be sure. Sustainability can no longer be ring-fenced to a specialist department; every team must be conversant with sustainable investing and green issues.’ The other reason is both investors and asset managers have the chance to be on the right side of history. As Mary Jane McQuillen noted, ‘through innovation and capital, we can actually effectuate a lot of important change.’ Investors must push companies to keep improving But how do investors maximise the potential of this moment – and how to identify companies that will make a lasting difference to tomorrow’s norms? Firstly, a huge amount of research is required. The panel noted the importance of ‘boots on the ground’ – local teams that can identify trends in their territories and build relationships with both business leaders and policymakers. McQuillen talked about ClearBridge’s analysts’ multi-decade experience in engaging CEOs and CFOs on both fundamental and ESG factors, that as long-term investors (average holding period across the firm is six years), company managements have been more responsive on sustainability improvements (climate risk mitigation, diversity & inclusion, financial inclusion, etc.) when addressed directly by the owners of the stock. Another key point referenced by the panel was the need for positive dialogue with portfolio companies; investors must push companies to keep improving the way they treat their employees, their suppliers and the environment. Ness suggested that while the investment community has focused on ‘inputs’ up to now (how ESG ratings are constructed and metrics are defined), it needs to start focusing on ‘outputs’, or the ‘so what’ of sustainability. ‘We’d argue that there’s a dual purpose to sustainable investing. ‘It should be the generation of both attractive investment results for our clients, but also, better outcomes from a societal and an environmental perspective.’ By holding the company conversations through both an investor and sustainability focus, real results can be procured. McQuillen told the panel that after more than a six-year series of engagements hosted by her and her colleagues, a ClearBridge portfolio company was able to reduce it water usage by almost 100% (making a technology manufacturing breakthrough that was previously not possible) and saving millions in water procurement costs, as well as creating a reputation boost that curbed employee turnover. ‘I think the incentives have to be there sometimes,’ she said. ‘They shouldn’t always have to be there, but if you’re able to express them in a clear, rational way, we have observed that our portfolio companies will also be very receptive.’ The world is trending toward a greener future As well as being proactive with companies, asset managers must be pragmatic with clients. Sustainability is still an evolving area with widespread discrepancy over even its most basic definitions. Both Ness and Cameron referred to the ‘grey zone’, suggesting that companies’ approach to issues such as energy usage must be framed by content and reasonable expectations. With this in mind, Ness suggested it is important to acknowledge the ‘messiness’ in ESG – particularly in emerging markets, an area he specialises in. ‘The more that we can be honest with the market and honest with our clients about the challenge of doing this without promising the world, then I think it becomes, perhaps, a much more credible movement.’ But while asset managers must remain cognisant of the challenges of ESG and sustainability – and try not to force clients to transform overnight – they can take heart from the underlying trends. The world is only going one way, and that’s towards a greener future - so the business case for sustainability will continue to get stronger. ‘I often think of ESG analysis as essentially just good business analysis,’ Cameron said. ‘Ultimately, it’s factors that benefit companies over the long-term that we’re talking about here. ‘Environmental, social and governance typically are good indicators of long-term performance - and businesses that will beat the competition.’ And, McQuillen added that investors in listed equities have a key role to play to keep sustainability a forward-looking priority for the capital markets, policy makers and society.’

OVERVIEW

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OVERVIEW

SUMMARY

Important Legal Information This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton. The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal. Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton ("FT") has not independently verified, validated or audited such data. 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¹ https://www.morganstanley.com/ideas/sustainable-investing-sentiment-covid-19 ² As of 11/07/2022 ³ As of 11/07/2022 ⁴ https://www.scientificamerican.com/article/renewable-energy-is-surging-but-trouble-looms/ ⁵ https://news.globallandscapesforum.org/57674/despite-global-turmoil-outlook-stays-positive-for-sustainable-finance/ ⁶ https://www.ft.com/content/b58c68d2-1cff-400e-ac2e-982333c85c89 ⁷ https://www.telegraph.co.uk/news/2022/07/10/ditching-net-zero-would-electoral-suicide-conservatives/ ⁸ https://www.rnz.co.nz/news/national/470749/climate-change-poll-tolerance-dropping-for-those-who-build-in-harms-way

Has the role of sustainable investing changed?

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These guys know a thing or two about where to look for opportunities these days We brought experts from different fields of expertise together and quizzed them on all things income. The gist of it: opportunities are galore. Be it in infrastructure, equities or bonds, there’s something in it for everyone. Watch the video to find out how to achieve a sustainable income in a volatile and highly inflationary environment – and why we need more scientists in portfolio management.

Income is the outcome

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Shane Hurst

Managing director at ClearBridge Investments

William Vaughan

Associate portfolio manager at Brandywine

Ben Russon

Co-head of UK equities at Martin Currie

Generating income in a volatile, inflationary environment has proven increasingly challenging in the global landscape over the past 18 months. Knowing where to look and taking advantage of current tailwinds in the market is becoming like separating the wheat from the chaff when it comes to creating stable returns over time. In a latest panel session sponsored by Franklin Templeton, we take a look at the hidden pockets of value with the help of three experts in their respective fields: Shane Hurst, managing director and portfolio manager at ClearBridge Investments; Ben Russon, co-head of UK equities and fund manager at Martin Currie; and Will Vaughan, associate portfolio manager and research analyst of global fixed income at Brandywine. Together they explore different approaches, asset classes and geographies to identify potential inflation hedges and attractive dislocations in the market, as well as investment opportunities. With the post-pandemic markets having created a tough environment for investors, our panellists are nevertheless excited about the opportunities – some of which are closer to home than others. The UK is one of them, having re-emerged as a rising star after a period of political instability, weakening of the pound and the devaluation of equities. ‘It’s been a difficult few years going back to the Brexit vote in 2016. Then obviously, we had the pandemic and the war in Ukraine erupted, causing more volatility in UK equities and leading to a shift in sentiment away from the asset class. Overseas investors have been less keen to participate in UK equities,’ says Russon. ‘A lot of that is now behind us and we find ourselves in a position, where the UK market is trading on a PE ratio of around ten times, yielding nearly 4%.’ Compared to European equities, the derating of the UK has rendered its equities relatively attractive in terms of value, compared with both its own history and international markets. ‘It’s one of the cheapest equity markets out there. It is one of the highest yielding equity markets out there. So on cross-border comparison it looks like an attractive starting point for investment,’ adds Russon, who has been a senior portfolio manager at Martin Currie since 2013. Infrastructure and energy could become two of the biggest investment themes over the coming years – even decades – as well as being robust inflation hedges due their ability to pass through costs, some of which include rising energy, labour or material prices. Decarbonisation or clean energy spend is expected to reach $36tn by 2050 to achieve net zero*. Utilities and infrastructure are at the forefront of this decarbonisation trend, offering potentially stable returns in the medium and long term. ‘Globally, utilities need to electrify their grid. If we think about electricity usage as a percentage of energy, that’s likely to increase from roughly 25% now, up to 50% by 2050. Why does that need to occur? According to global policies, we are moving towards electric car sales of over 60% by 2030. For us, investing in utilities means this investment in the grid gets put into an asset base and we’re able to earn a regulated, very stable return going forward,’ explains Hurst. ‘When you think about contracted and regulated renewable assets, renewables are becoming a larger part of the grid. Coal is being phased out and investment in gas is largely being flatlined. That means that we’re going to get huge growth in wind and solar capacity – some expect almost 500% by the end of 2030. So we’re set for massive amounts of growth, globally, from current levels.’ Flexibility in approach even within the same asset class and innovative investment thinking were highlighted as additional growth drivers in the current environment. Brandywine’s philosophy of treating duration as an asset class on both the long and short side has better enabled the firm to gain returns even in challenging macroeconomic environments. ‘It’s important not to be wed to a particular sector. It’s about avoiding having these biases. It’s the ability to look across sectors and across asset classes for these valuation anomalies and these disconnects where we see value. For example, it’s not always the right time to be in high yield, whereas potentially, there are many other opportunities,’ says Vaughan, who holds a rare masters degree in carbon management and economics and tends to view opportunities from both a science and a financial vantage point. ‘Currently we’re seeing some very attractive dislocations in the US mortgage-backed security space and potentially that long-end duration, which we expect to continue to rally over the course of the year, to gain both diversification and stability of returns.’

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OVERVIEW

SUMMARY

Old habits die hard, but shedding old biases is absolute key to finding value across the tricky market landscape, our panel reveals.

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* Source: International Energy Agency Report as at October 2022

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Has the role of sustainable investing changed?

"It’s the ability to look across sectors and across asset classes for these valuation anomalies and these disconnects where we see value."

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Locating the dislocations

Source: International Energy Agency Report as at October 2022

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sustainable investing: where are we today?

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Mary Jane McQuillen

Head of ESG investment and portfolio manager at ClearBridge Investments

Craig Cameron

Portfolio manager at Templeton Global Equity Group

Andrew Ness

Portfolio manager and deputy director of research at Franklin Templeton Emerging Markets Equity

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Sustainable Investing: How to turn global crisis into opportunity

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