Owners have to care about sustainability – It is an investment risk

In this Nordea On Your Mind, “Nordic sustainability champions,” interview, Eric Pedersen, Head of Responsible Investments at Nordea Asset Management, points to the evolution of sustainability from being a moral niche for certain types of investors, into being perceived as a material investment risk by most professional investors. Regulations such as CSRD and MiFID have also been powerful drivers for the sustainability focus, particularly in Europe. The Nordic idea of a social license to operate, taking into account interests from stakeholders other than owners, has also been an important factor.

Viktor Sonebäck (VS): Can you give a brief overview of how responsible/sustainable asset management has evolved over time? What have been the key changes? Have companies become more transparent? Higher data quality and availability? Would you say it is a mature investment space or is it still under development?

Eric Pedersen (EP): The development of responsible investing or ESG investing over the last 20 years started with slow but steady growth, accelerating dramatically with the introduction of SFDR in Europe and the realisation that especially climate risk has become very real and highly material to investors across the spectrum. 2004 saw the first use of the three-letter acronym, marking a change from the ethical investment practices followed by some faith-based, labour union and benevolent foundation investors, into modern responsible sustainable investing.

The main difference was an explicit realisation that sustainability risk can be not only a moral consideration but also often material investment risk – with ESG presenting a toolbox to analyse this risk across multiple dimensions: Environment, Social and Governance. In 2006, the United Nations launched the Principles for Responsible Investments (PRI), and ratings and ESG data started becoming available in increased degrees of sophistication. ESG investment volumes it literally exploded in the runup to SFDR, which came into effect in 2022. Interestingly, the Nordea Climate and Environment fund, with over EUR 10bn and now one of the very largest Article 9 funds (funds that have sustainable investments as their objective) in the market, only really started growing fast from 2020-21.

Currently, even with the market taking a breather following the invasion of Ukraine and the resulting cocktail of oil & gas and defence outperformance and higher inflation, which was a poisonous cocktail for ESG fund performance, a full 60% of EU fund assets are Article 8 (funds that promote environmental or social characteristics) or Article 9 funds. For the companies that funds invest in, this has meant much higher demands regarding their transparency, and on the whole they have delivered on this – data has become much better. And when CSRD really kicks in, it will be better still, especially for companies based in or active in Europe. Still, methodologies and really the depth of analysis and understanding of the complex transition dynamics faced by many companies are very much under development.

The problem is that there are a lot of myths out there, where a good ESG analyst needs to understand both the market demand changes, the regulation coming into place and the technologies that can be used, to see through them. The big dreams about hydrogen powering everything is one example. Yes, it will play a role, but in many applications the physics really mean that direct electrification is much more cost-effective.

VS: What has driven responsible investment growth and development? Increased investor demand? Regulations on the asset management side and/or corporate side? Something else?

EP: I have always said that there is a huge latent demand for sustainable investing – latent in the sense that investors need to be asked: "Do you want to invest sustainably?", and then many will say yes. Institutional investors have also made, for example, climate commitments that they need to live up to. But there is no doubt at all that regulation, in the form of SFDR and the MiFID requirement to ask customers about their sustainability preference, is what really kickstarted it all. By forcing fund managers to declare that their funds are either to some degree sustainable or not at all, a lot of ambitions were set and the industry started hiring ESG professionals and buying data like crazy – even the firms that had never shown much of an interest.

VS: Does the Nordic corporate universe stand out compared to global peers? If so, in what key ways?

EP: Nordic corporates definitely stand out as generally very high quality on ESG parameters. This has to do both with the industry mix in the Nordics but also societal expectations, environmental and labour laws – and the whole idea of a social licence to operate and taking into account more stakeholders than just the literal owners, which is just stronger here than in most parts of the world. And then Europe in general is stronger than the US, with emerging markets generally still earlier in their journey towards more sustainable business models.

Nordea climate and environmental strategy AUM, 2018-2021 

VS: How does Nordea Asset Management work with responsible investments in practice? Exclusion/inclusion lists? Board/management involvement? Specific ESG strategies?

EP: NAM today is in the top five, if not the top three globally, in terms of our standing as a responsible investor. The level of exclusions – or selective inclusion – differs from product type to product type. Not all investors have equally strong ESG preferences and, for example, a climate fund or a fund with a diversity theme is different from a broad-based ESG strategy. We are by far the Nordic investor that is most active in stewardship, from dialogues with investee companies to voting, AGM resolutions and so on. Our team of 25 pure ESG analysts is one of the largest in the industry globally, especially in relation to the size of the firm. And to that, one should add all the many portfolio managers who exclusively manage ESG, responsible, and sustainability-themed strategies.

VS: Do you see any major differences in how sustainability is approached as an asset manager within the equities versus fixed income spaces?

EP: On the one hand, fixed income – when one considers new issuance – is the area where one can have the most influence on a company's relative cost of capital. On the other hand, bonds tend to react less dramatically to adverse ESG news than equities.

Engagement is also not as straightforward – but it is possible. So there is a reason why fixed income is often seen as harder to do sustainably. We feel, however, that we have a very good handle on it, and we have a wide range of ESG-focused fixed income funds, both the obvious green/labelled bonds, but also in areas like high yield.