This series is supported by our partner Aegon Asset Management. It explores how financial institutions are using the SDGs in their financial products across a range of asset classes. The series also includes briefings on the move from ESG to the SDGs and the SDG Impact Standards.
The business case for financial services aligned with the UN Sustainable Development Goals (SDGs), the world’s development agenda, is not fundamentally different from the case for environmental, social, and governance (ESG) considerations: they represent economic risks and opportunities.
The difference between ESG and the SDGs is that the former primarily represents considerations (e.g., climate change, gender and diversity) and associated methodologies for addressing these (e.g., exclusion, best-in-class selection) whereas the latter are goals (e.g., gender equality, affordable and clean energy).
Adopted by over 190 United Nations member states since 2015, SDGs have become the language of development. There are 169 targets and 231 unique indicators that sit underneath the 17 SDGs, helping to bridge goals and actions.
Unlike such frameworks as the UN Principles for Responsible Investment, the SDGs were not drafted for investors. Some of the SDGs seem better suited to alignment in investing than others. For example, decent work and economic growth (SDG 8) and industry, innovation and infrastructure (SDG 9) are probably more relevant to asset managers than zero hunger (SDG 2) and quality education (SDG 4).
Companies are paying increasing attention to SDGs. According to a report (2019) by Bloomberg, “Companies are using SDGs to position themselves on sustainability, with about 60% of the Bloomberg European 500 Index and Japan’s TOPIX 500 — along with about 30% of the S&P 500 — discussing the goals in their reports.”
Spotlight on Listed Equities
While SDGs may seem best suited to impact investing, SDG aligned products have been introduced across many asset classes, including listed equities, where engagement is the key method used to align with the SDGs. Examples include Federated Hermes’ SDG Engagement Equity Fund, RobecoSAM Global SDG Engagement Equities and BMO SDG Engagement Global Equity Fund.
Engagement is key to SDG alignment in equities because listed companies do not prefer to raise fresh capital by issuing shares nor do they intentionally align with the SDGs. There is little, if any, impact that can be attributed to trading shares in the secondary market but engagement with companies to improve their performance related to SDGs is a clear possibility.
The quantum of funds under management increases an asset manager’s influence and a tried and tested engagement process followed by experienced professionals year after year improves its effectiveness.
Engagement is likely to be combined with some degree of exclusionary screening (e.g. tobacco, armaments) and identifying small to medium companies that offer products and services beneficial to society and the environment, such as clean energy, healthcare, or waste management.
The fact sheet (June 2022) for Federated Hermes’ SDG Engagement Equity Fund states that engagement is supported by its dedicated stewardship team, 98% of AUM were engaged and 51% engagements were able to make progress. According to the stewardship team’s plan for 2021-2023, engagement is a four-step process, concern is raised with the company, company acknowledges the concern, company develops strategy, and then implements it.
RobecoSAM reports that its SDG fund invests in companies with economic potential “that are in the middle” regarding sustainability performance because “that’s what offers the most opportunity for improvement” through engagement, thereby “turning caterpillars into butterflies”.
In its Impact Report 2021, BMO says, “We have developed our engagement database to include the underlying 169 SDG targets of the 17 goals, which allows us to log interactions, progress and results to a granular level where relevant.” According to the report, 35% of engagement links to Responsible Consumption and Production (SDG 12) and 27% links to the underlying target pertaining to encouraging companies regarding sustainability practices and reporting. The report adds that during the year, votes were cast against management of companies on 13% of resolutions, “with remuneration the area of most concern”.
The use of engagement as the key method for aligning with SDGs raises an important question: can any asset manager that lays a claim on active ownership also claim SDG alignment for any listed equities fund?
One possible answer to this important question is “Why not?” while another is “Definitely not!”.
The “Why not?” answer is based on the view that if engagement does integrate SDGs, then the fund deserves to claim alignment and may also use the SDG label. Engagement by asset managers ought to follow demands of their clients and if the clients require SDG alignment, then the fund label should say so. A report by OECD, Framework for SDG Aligned Finance (2021), brings home the point that SDG alignment is “just a means of enhancing the likely sustainability impact”. Such labels simply communicate the means (engagement) and the ends (SDGs) and there is nothing wrong with them.
The “Definitely not!” answer represents the alternative view that SDG label runs a real risk of becoming one more box to check and one more buzz word in the marketing materials. In other words, large scale ‘SDG-washing’ would render alignment-through-engagement meaningless. Not everyone is impressed with engagement by the investment industry anyway. Take for example, ShareAction, a charity that promotes responsible investment, which has been critical of the level and quality of engagement by the world’s largest asset managers on key issues such as climate change.
Arguments can be made for both answers. In any case, at present there are very few funds claiming SDG alignment and fewer still that are using the SDG label. Of the list of nearly 4500 funds maintained by the Investment Management Association, there are four with SDG in their name, out of which only two are listed equities funds. The concerns about SDG-washing in listed equities are perhaps outweighed by the need to further explore and develop SDG alignment.
SDG Financial Products was launched at COP26 by GEFI and showcases commercial financial products that are aligned to the SDG in order to share learnings and grow the ecosystem of SDG aligned financial products across asset classes.
The SDG Impact Standards provide guidance on developing an appropriate strategy, management approach, transparency and governance to assist businesses and investors in contributing positively to sustainable development and achieving the SDGs. The Impact Standards also provide a decision-making framework to make sense of existing relevant principles, frameworks and tools.
