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Rise of ethical investments turns managers into ‘detectives’

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A casino that tolerated reckless gambling, a supposedly lucrative real-estate portfolio containing empty or sub-standard properties.

These are some of the realities investors have found lurking behind the increasingly popular ESG label used by companies to attract money from socially aware savers.

That label though, may not always apply accurately to some investments. As a result, a growing number of fund managers is having to adopt due diligence techniques more akin to those used by private investigators to ensure they aren’t putting money into fossil fuel burners, arms manufacturers or users of sweatshop labor.

Not going that extra mile risks the loss of potential clients to competitors, according to James Turner, head of European leveraged finance at BlackRock International.

“Many of our clients, especially Dutch and Nordic investors, have a higher focus on ESG policies, and won’t invest without knowing that we have a robust ESG process,” he said.

In the last five years, the universe of sustainable investment funds has increased almost 70% to $760 billion in European and U.S. mutual funds and ETFs, according to data from Morningstar.

Though an increasingly large part of the investment industry, especially in Europe, there’s no standardized formula behind the issuance of an ESG label. Companies are largely left to make their own decisions on whether they qualify for the standards of socially and environmentally aware clients when marketing new bonds.

Muzinich analyst Ian Horn said his employer once ended up selling its holdings of a real estate company’s bonds after he visited the sites of some of their properties in Germany. One turned out to be largely vacant, another proved inaccessible and the management team couldn’t locate a third.

In another example, Chris Brils, portfolio manager at Actiam tells of how at one point in a previous job, he had to spend some time around high-stakes tables in Las Vegas casinos to get a firsthand account of what behaviors were tolerated in the gaming companies he invested in.

Assurances of ethical credentials from management aren’t always good enough, Brils said.

“You have to pick your battles generally and decide to do more stringent research on the firms that you think need a bit more investigating,” he said.

The top 20 are now home to nearly $1.2 trillion in combined assets.
January 9

While a thorough investment-review is not a novel practice in the fund management industry, having financial analysts actively perform some of these private-eye duties more regularly, is becoming more accepted. Analysts spoke of their use of websites tracking ship movements via GPS and Chinese customs databases, while others recount even having to pay close attention to the body language of companies’ management during meetings in search of clues to questionable behavior.

Without an industry standard or recognized centralized body making decisions on what’s ethically, socially or environmentally acceptable, applying the ESG label is a subjective process. But that “subjectivity” can also be a strength when trying to get ahead of other fund managers, according to My-Linh Ngo, head of ESG investment risk at BlueBay Asset Management.

“You’re trying to pick up signs that later on may manifest themselves in numbers,’’ she said. “The question is will the market also decide there’s a problem or are you too early?’’

Bloomberg News