The different roles of ESG from strategy to stock picking

Randy Brown, chief investment officer at Sun Life & head of insurance asset management at SLC Management, discusses the integration of ESG consideration at various company level from strategy to asset selection, and where Sun Life is in its sustainable investment journey. Interview by Vincent Huck

How does one integrate ESG at the SAA-level rather than the selection level?

Historically, I don't believe that ESG would have been incorporated at the strategic asset allocation level, it would have been at the asset selection level. Now that sustainability has taken on more prominence and more expediency, people are starting to think about it at the strategic asset allocation level as well.

There are two areas of consideration here: one is, 'if I'm going to hit a 2025 and 2030 target for some 'carbon intensity' reduction in my portfolio, that may come down to individual asset decisions, but it may also come out as sector allocation decisions, as I deploy new money'. The other area of consideration is exploring if there are parts of the capital markets that we don't currently invest in that perhaps, with the lens towards ESG, we should.

As an example, we don't invest in early-stage equity investments, i.e venture capital, early-growth, mid-growth, etc. So one of the things I think about is: should we invest in those as a way to capture economic value from emerging technologies? And, as a way to gather insights that may impact the pace of change in our portfolio?

What do you mean by "gathering insight"?

Let's take a simple example, one of the weak links in the energy value chain is storage. You can have all the windmills and solar arrays in the world that you want, but they're only as good as when the wind blows and when the sun is shining. If that is not aligned with the demand for energy, then you have a problem, in that you need other forms of energy generation or better storage.

So, if you have a lens into emerging storage technology, you may be able to gather insight to what that means for the rest of your portfolio. Otherwise, if not, then you don't know what's coming, and you're just reacting after the fact, so it helps you to better anticipate.

What other knowledge gaps can you highlight that could be addressed?

There are a lot of innovations going on, one area where there will be a lot of breakthroughs is going to be on GHG intensity, anything from carbon capture to energy storage.

Even in the renewable space, a lot is happening. Look at new iterations of the efficiency of solar arrays. What does that mean for my existing solar array, when somebody comes out with one that is better, lasts longer, is cheaper, whatever the break point is? That may affect my decision on new or existing projects.

Is it fair to say that the integration of ESG consideration at the SAA level is more philosophical? Whereas asset selection would be more analytical?

There is still plenty of analytical rigor that would need to go into the SAA as well.

As an example, if you have a long-duration investment-grade fixed income portfolio in North America, you probably have a larger exposure to utilities, energy and industrials, since those are the companies that are issuing longer investment-grade corporate bonds. Thinking about it strategically: Do I want to keep buying those which, today at least, tend to be some of the larger carbon emitters? Are there other asset classes I want to find as a substitute for that long-duration, corporate bond piece of my portfolio? Because just doing what I've always done may increase my carbon intensity in the short term.

Aren't those more philosophical questions rather than analytical?

The first part of the 'analytical' is, what is the carbon intensity of that part of the capital market, relative to others and what are my alternatives? If I buy less of X today then I have to buy more of Y – and that's all analysis of what's the yield give-up, what's the duration give-up, and credit quality differential that will go into the models to say 'that will support my liabilities'?

As an industry that is very ALM-driven, there is a lot of analytical rigour that would go into that decision on the strategic piece: Are there alternatives that I could buy?

I could buy government bonds, but that is a big yield give-up. I could buy agencies or provincials, but that's still a big yield give-up. I could buy some form of structured finance, or I could do swaps, to get the synthetic duration.

So there are choices, which all come with pros and cons in terms of the yield, duration, credit quality, and the ALM match, which has implications for my capital consumption.

All of that is the analytical work at the SAA level.

You said ESG historically hasn't been a driver in the SAA, how much of a weight does it have today?

It's something that we're thinking about as an input. I would say that we are probably still in the 'thinking about it' stage. I would speculate that some of the European companies may have it factored into their SAA already, and the North American companies probably don't.

Would it be fair to say that when thinking about ESG, North Americans are more focused on the resilience of their portfolio, rather than the impact of the company's organisation on things like the climate impact for example - unlike Europeans which may look at both?

We are probably more focused on measuring and reducing GHG intensity. Some European insurers report on the Celsius-degree-rise that their portfolio would help produce.

Some are very precise in their disclosures, saying: 'If we leave our current investments unchecked, it would lead to an X-degree rise in temperature.' I wonder how accurate that precise figure is, because I doubt that today you can get greenhouse gas intensity figures for the whole of your portfolio. You can get a reasonably accurate figure for a section of the portfolio, but not all of it.

We have a big data problem at the moment. By and large, we're all aligned that there's an existential risk, and we all have to do what we can to help solve that. There's a push for immediacy, and in my opinion, there's a misalignment between expectations and the reality of what we are able to actually measure and do today.

It's going to take time to get accurate data.

What is the next step in Sun Life's ESG integration?

We're thinking about data. How do we get a better handle on data to measure the intensity of our portfolio? We also spend a lot of time thinking about the value chain I was explaining earlier, and how to gain insights into new innovations. As a company, we are spending a lot of time thinking about what our public commitments should, and will, be.