ESG Investing, mutuals vs listed insurers

In the first part of this Insurance Asset Risk/ Royal London Asset Management roundtable, insurers discuss how the nature of the insurance business – mutual or listed - may or may not impact how organisations think about ESG integration.

Vincent Huck: How are you considering ESG in your investment decisions, and briefly what is your company's strategy when it comes to ESG or sustainable investment?

Lauri Seraste: Our sustainability investment strategy started at our asset managers' level. They have been doing quite a lot of work around sustainability. We are now working on bringing that back into a group-wide strategy and also integrating it in our strategic asset allocation.

Kristofer Dreiman: On the investment portfolio side, speaking of responsible investing, the long-term objective is to be carbon- positive by 2045. Our interim target, to achieve this long-term objective, is to reduce our carbon footprint by 50% by 2027 compared to 2019 levels.

We have steadily increased our allocation to sustainability- labelled bonds. They now represent more than 20% of assets under management.

Erik Ranberg: For us, ESG is a long journey. We actually started in 2005 with sosial responsible investments (SRI). The focus at the start was labour abuse, nuclear weapons, cluster bombs, porn etc. Exclusions was the main tool to express our concerns. Now ESG has evolved, particularly also in the last couple of years, and we've moved from exclusions to an overall group ESG policy. Climate has in particular grown as a subject. We still use exclusions as tool to make the portfolio compliant to our ESG policy, but interaction has become more frequent also. Further as regards managing the climate strategy regarding carbon, to be compliant with net-zero in 2050 we are trying to implement carbon pricing into the portfolios. The group's objective is to reach net-zero by 2050, and as the CIO, I'm trying to find the different tools to go down that path in a consistent way.

Unlike what Kristofer mentioned, and what other insurers are doing, we are not allocating to so-called sustainability bonds as such, because we believe that a lot of what's sustainable today will not be sustainable tomorrow.

So we try to do it through the pricing in the capital allocation, which also enables us to steer the external managers.

Thor Abrahamsen: In terms of ESG, we have been somewhat, I wouldn't say 'passive' – as per Lauri's comment, we had a requirement on how to manage the ESG process via our asset managers. They have done a lot of work on that side and we left it to them. We are now trying to figure how to bring it back within the insurance company. We, of course, have a policy, but are trying to formulate it on the strategy level.
From an investment portfolio perspective, we've done some direct investments in ESG funds, and we launched an impact fund with one of the managers.

Andrew Epsom: Royal London is the largest mutual provider of pensions and life insurance in the UK – Royal London Asset Management is its affiliated asset manager. We currently manage around €182bn of assets, approximately €125bn of which comes from our parent Royal London with the remainder from external investors such as other insurers. We have a substantial, experienced responsible investment team of 17 individuals, of which Ashley [Hamilton Claxton] is the head.

Ashley Hamilton Claxton: We have a very large team responsible for leading all of our company engagement and working with fund managers around company engagement, voting all of our shares and proxies in our equity funds, coaching and helping around ESG integration within investment processes, subject matter expertise and thought leadership.

We have a sustainable range of funds that's about £13bn, made of nine different funds across the spectrum, from 100% equities to 100% fixed income.
And last year, we made a bold move, by moving all of our passive equity – that's around £20bn – out of market-weighted tracker funds into ESG-tilted and low-carbon funds.

Vincent Huck: Kristofer, you wanted to respond to Erik's comments?

Kristofer Dreiman: On a high level, I agree with your statement Erik. It's worth clarifying that, with the exception of the existing ESG related exclusion and also transition criteria we have in place for listed equities, the objective that I refer to in terms of sustainability allocation is linked to our fixed income allocation. What we've done is to swap, over time, the exposures to green, social, and sustainability-theme-labelled bonds from predominately SSA issuers, where we know what the use of proceeds will be earmarked for beforehand.

Erik Ranberg: How do you secure different stakeholders' interests when you do this?

Kristofer Dreiman: It's interesting especially in a mutual context. Part of the investment universe is municipalities in Sweden, and we're a federation owned by 23 local mutual insurance companies in 'counties' across Sweden, to simplify the description. So if we invest in a green bond from the county of e.g. Stockholm, those in Sweden's north or south might wonder why we don't invest in something equivalent, in their geographies. That's why we tend to avoid the municipality bonds, in order not to tread on any sensitivities linked to our various owners and stakeholders across the country.

The group has, with regards to asset management, decided to prioritise a subset of the Sustainable Development Goals (SDGs) – specifically SDGs 3, 7, 11, 13 and 15. What we do in the evaluation of these bonds is to make sure that at least a sub-set of use of proceeds are allocated to at least one, if not more than one, of the prioritised SDGs. We also evaluate the environmental and/or social impact of respective bonds against those we have in the portfolio.

In that way, we try to make sure that we keep our stakeholders happy, but also over time increase the impact of the investment.

Ashley Hamilton Claxton: In our sterling credit business, we've been a little bit sceptical of the use of proceeds of those bonds, the money is quite fungible, and so we've been very cautious about them. And we do feel like sometimes it's a very easy label. So a lot of investors, if they want to take a shortcut, can buy a labelled bond and 'job done'. So, I'd be interested in Kristofer's view about what the quality of those bonds are from a sustainability perspective?

Kristofer Dreiman: We are still very sceptical about the so- called sustainability-linked bonds, especially in the high-yield and investment-grade market where the objectives presented by the companies issuing these have not been that ambitious, maybe not even aligned with science. It's worth noting that we don't have any exposure to investment-grade or high-yield in our portfolios, it's only to SSAs and covered bonds. It's a quite concentrated portfolio with names that you can most likely think of, like the European Investment Bank, the World Bank, Sweden's Kommuninvest, and Asian Development Bank, to name a few. It's a relatively easy portfolio to monitor from both financial and ESG perspectives, we have 20-25 names, and have a very close engagement with them.

"I think mutuals may be a bit more flexible on the use of capital, to maybe take a bit more risk – go a bit further in some products or conditions"
Lauri Seraste

With those issuers we feel comfortable that proceeds are allocated to listed environmental and/or social project categories. We also encourage them to hire a third-party auditor to make sure the impact statements that they produce, on the basis of what has been financed, actually are accurate. That said, obviously there is room for improvement for the market as a whole.

Lauri Seraste: From a mutual insurer's perspective operating only in Finland, we see our main stakeholders as being our customers. This means we need to have ways to communicate what we do around sustainability, and not just investments, but the business as a whole. And it goes beyond the regulatory requirements that are coming out, be it the taxonomy, Article 8 or 9, or disclosure requirements, but really to communicate to our customers at a local level, what we as a business understand to be 'sustainability' and what actions we are taking in that sense.

Andrew Epsom: It's interesting that most people here are representing a mutual insurer, apart from Erik. Should there be a different approach for listed insurance companies and mutual insurance companies, in terms of how they view sustainability?

From Royal London's perspective, we're always very keen to point to the fact that we're a mutual. We believe this facilitates a longer investment time horizon, which aligns very much with the concept of having a longer-term strategic vision for sustainability, and to support transition activities. So, we see mutuality as very much aligned with sustainability.

From a listed company perspective, there may be the tendency to focus additionally on a shorter time horizon – for example in managing the annual P&L for shareholder objectives. But having said that, there also tends to be increased transparency requirements for listed companies around climate risk, which perhaps increases the focus on sustainability.

Vincent Huck: What role has mutuality got for your sustainability policy?

Ashley Hamilton Claxton: The benefit of having a mutual owner is that they are willing to seed new funds and give us what I call 'patient capital' to start new ideas, which perhaps in a listed company is more difficult.

But equally, there are probably a lot of benefits on the listed company side as well.

Erik Ranberg: It's interesting you say this. Two-thirds of my career has been in a mutual company, one-third in a listed company. I find this distinction you make between being a mutual and not a mutual interesting, because going from a mutual to being listed is not that big a step, actually, as regards to how we should think as economists to contribute to sustainability. Take carbon for example – how do we get the right kind of adjustments to bring carbon emissions down? You wouldn't approach that question very differently if you work for a mutual or a listed company.

If you take governance and social issues as another example, it's not hard for me to exclude porn, being a private or a listed or a mutual, that's not a big deal.
But the big deal is how to contribute in the best way to get the climate adjustment that we need globally? How do I translate those adjustments into a methodology that works for an economist or an investor? I don't think there's a big difference between a mutual and a listed insurer, to be honest.

Ashley Hamilton Claxton: We all have a common goal don't we? So perhaps it doesn't matter the structure we're in.

Thor Abrahamsen: I slightly disagree with you, Ashley, because one of the things which is the problem here, is that ESG is being misused. What I mean by that is that a lot of ESG equity funds, for example, are bloody nonsense. Not all of them, but a lot of them. The portfolio is nonsense, it's got nothing to do with sustainability, but it's about putting tons of different companies

in there and eating off the fees. Because that's the finance industry, we hide fees behind complexity and 'hype names', that's what we do. That's what we've been doing for 100 years.

"A lot of ESG equity funds, for example, are bloody nonsense. Not all of them, but a lot of them. The portfolio is nonsense, it's got nothing to do with sustainability" Thor Abrahamson

So the question here is, how do we now do it in a sensible way? How do we use capital, put it into play in a good way for the environment around us?

Ashley and Kristofer talked about being sceptical about green bonds, and I completely see that. In the same way, I'm deeply sceptical about a lot of things I see on the equity side. How do you invest in the transition? It's easy to pick a branded or labelled fund, invest in it and say 'we've done our part'.

But the transition is more complex than that. For one thing, there's a lot of things that are needed to achieve the transition which might not be green today, so what do you do with those? And second, a lot of the focus is on climate because it is very much at the forefront of people's minds and goals, but it sometimes comes at the expense of the 'S' and 'G', which is counterproductive.

I don't think the industry has helped itself. Because the more ESG gets misused then the more sceptical everyone is. Going back to the discussion on stakeholders – and mutual versus listed insurers – it's very easy for a company's owners to say we'd like to focus on sustainability going forward, because we have a long-term horizon as long-term investors, and so on. Something happens in the market and suddenly it's like, 'oh my God, what do you do now?'

So are we really investing for 10 years here, or for three months?

That is a hard balance to achieve: finding cases to invest our capital in a good way, as good human beings, and at the same time looking after the interests of our owners.

Lauri Seraste: I think mutuals may be a bit more flexible on the use of capital, to maybe take a bit more risk – go a bit further in some products or conditions, then maybe make some strategic investments in some areas.

And that may be different at a listed company, where shareholders are looking for a return on equity.

Ashley Hamilton Claxton: Thor, how do we shift that? There's always that human nature, isn't there, about being really concerned about the here-and-now whilst trying to solve issues that are on the horizon.

Thor Abrahamsen: Some people think about humanity more than others. But the problem here is that the reward for investors is uncertain, because there's no pricing.

For example, if you had a global carbon tax – leaving aside whether that is a good or bad idea – you would have pricing levels where you can see the benefits of what you're doing.

The benefits now are mixed. ESG has been kind of hijacked, which means that, amongst the good things, there's tons of bad things. And it takes one bad experience to create scepticism.

Ultimately I think we're moving in the right direction with ESG, but we need the incentives to improve and that is difficult because ESG will mean different things to different people.

Kristofer Dreiman: To that point, we feel that the ESG service providers and their so-called ESG scores/ratings have a responsibility in this 'hijacking' situation. In general, the industry feels a lot of frustration about the upcoming new sustainable finance regulation, but one positive development is these providers will now be regulated to a much greater extent. Many have over the years relied on ESG scores or ratings from MSCI and the like, and it has misled the market, because these ratings capture at best some level of disclosure and policy content, but to a small extent companies' performance and impact.

Ashley Hamilton Claxton: It's fascinating that the whole industry has treated this ESG ratings as data, but it is not - it is an opinion. And if you treat it as an opinion it's fine, like you would with a broker recommendation.

Erik Ranberg: The statistics are on your side, Ashley. Because when you look at the ratings and the covariance between them, it's way out.

Ashley Hamilton Claxton: I'm perfectly happy with that, why would I want my research providers to all agree? You would never want your brokers to all agree on a buy-sell decision. You'd be very sceptical if they did.

Thor Abrahamsen: But that's why we chase returns, that's why no one ever got fired for buying IBM. Because opinions are scary, taking a subjective decision on something is terrifying, because if it goes wrong then it's your opinion which was wrong. And if you go with whatever consultants recommend, then that's their job, and you might have made a mistake, but it was their fault. But that's just part of human nature and the psychology of deploying capital.

Ashley Hamilton Claxton: And that's the beauty of active management, you're paying people to make judgement calls on very complex matters.

Thor Abrahamsen: But allocating capital to active managers in the first place is a subjective opinion. I agree with you, active management is the way to go. But I'm saying that's the reason why people like to just 'go passive', especially with ESG, it allows them not have an opinion and tick the box: we've allocated X% of our capital to ESG.

Read the second part of the roundtable here and the third part here.

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