DWS’ Plein: “The large growth in ESG strategies will kick in in 2021”

• Disclosure Regulation is a clear legislate mandate to integrate ESG
• DWS aims to embed ESG in all investment strategies and products
• It takes a data driven ESG approach

The European Union (EU) will implement the regulation on Sustainability-Related Disclosures (Disclosure Regulation) on 10 March 2021. It will require investment managers to provide greater transparency on the integration of environmental, social and governance matters (ESG) into investment decisions and recommendations, including those which do not focus on ESG mandates.

Oliver Plein, global head of investment specialists ESG at DWS, the asset management subsidiary of Deutsche Bank AG, believes it will increase investor demand for ESG focused investment strategies and products.

“The large growth in ESG strategies will kick in next year and thereafter because the regulatory pressure in Europe will increase in 2021. In March, the disclosure policy will start, where you need to display ESG risks in the portfolio, and in 2022, it will be followed by the EU taxonomy policy, where clients need to be asked by their advisors if they want to have certain ESG aspects disclosed. The demand for ESG related strategies will go up then.” he remarked.

The Disclosure Regulation is part of a wider set of regulatory requirements designed to encourage and compel financial services providers to help build sustainable economies of the future. It also includes the draft Taxonomy Regulation that creates a framework for the definition of financial products as sustainable investments.

It requires alternative investment fund managers (AIFMs), Undertakings for the Collective Investment in Transferable Securities (UCITS) management companies, portfolio managers and investment advisers approved under Markets in Financial Instruments Directive (MiFID), to put in place policies on the disclosure of sustainability risks and sustainability factors in their investment activities.

Disclosure Regulation is a clear legislative mandate to integrate ESG

While there is a clear legislative mandate to move towards ESG standards in Europe, there are similar pressures in other regions to better disclose and manage sustainability risks and factors. These are defined as “event or condition that, if it occurs, could cause a negative material impact on the value of an investment”, and “environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters” respectively. 

“We really see the differences between the various regions. It's driven by the regulatory priority in Europe, US and Asia. There is a huge demand in terms of climate focused strategies and this is two-fold. One is the management of transition risk in terms of stranded assets. Many institutional clients,  pension funds, endowments, or other large capital market players are really investing from a strategic point of view, with an allocation of 25 to 30 years and therefore are aware and want to have portfolios that have a tilt towards companies which do not have severe or high climate related risk in terms of transition risks. The other is about physical climate risk that can cause breaks in your value chain,” Plein observed.

Many asset owners are currently looking into the disclosure of climate related risks and there are various ways to treat it. DWS has started an ESG advisory service to help clients, key partners and institutions be aware of and manage climate related risks in their portfolios. And what can be done bring down the carbon dioxide (CO2) footprint as well as carbon transition risks and physical climate risks in the portfolio. However, he cautioned a proper engagement approach to reduce carbon footprint against outright exclusion or restriction from the portfolio. 

“We can’t avoid CO2 by simply excluding certain sectors and invest simply into business models that have zero emissions. Then, there is no support for global climate change because we need to help companies with a high carbon footprint to become better over time, to adopt a proper engagement policy,” he added.

DWS started five years ago to introduce ESG mirror strategies for all of its key capabilities so that clients have the choice between the traditional and the ESG versions. Plein believes that over time, the traditional strategies will “morph” into more ESG related ones because of regulatory requirements, pressure from investors, and the implementation of sustainability risks. In the medium term, over the next five years, he sees at least one fourth of DWS’ assets becoming ESG related.

DWS aims to embed ESG in all investment strategies and products

DWS is one of the largest asset managers in Europe and the world with total assets under management (AUM) of about EUR 767 billion ($902.2 billion). Plein shared that as a listed asset manager, DWS aims to embed ESG into all its investment processes and operations. He sees as this the licence to operate for fiduciary investors in the future – and to realise its ambition to be among the leaders of the movement.

“To ensure we can deliver on this ambition, we have spent a lot of time developing our sustainability strategy in 2019. We agreed to a new organisational set-up to manage sustainability across DWS; we have implemented ‘Smart Integration’ to increase our consideration of ESG criteria in the investment process and enhance our engagement activities; we have continued to build-out our global ESG product suite. This also includes enhancing our risk management framework, and introducing new sustainability key performance indicators (KPIs) to make sure that we track meaningful progress on delivering our commitments,” he elaborated.

Prior to the movement towards ESG integration, DWS has been providing sustainable and responsible investment strategies for more than 20 years. In 2007, it started to incorporate ESG factors in the investment process, embedding ESG related risks and opportunities into its investment processes as part of its fiduciary duty. DWS was amongst the early signatories of the UN-backed Principles for Responsible Investment (PRI) in 2008.

It currently has more than 35 different mutual funds which are completely aligned with ESG standards. As of end of 2019, EUR 40 billion ($47.1 billion) out of its EUR 515 billion ($607.1 billion) worth of managed funds were in actively managed ESG funds.

To some extent, DWS’ AUM also include the impact investments that meet the higher positive contribution requirements of the United Nations Sustainable Development Goals (SDGs). However, they are not managed as strict and dedicated impact funds. Nevertheless, all of the issuers must comply with its ESG standards.

“The key question is, how you define as an asset manager, the link between the corporate issuer and the alignment of its business model to the SDGs. You can, for example, try to find how much revenue the company is generating from certain SDGs, against the threshold you looking at? Is it more than 10%? 25%? 50%?” Plein proffered.

It takes a data driven ESG approach

Like many asset managers, DWS takes a data driven quantitative approach to defining, measuring and reporting ESG risks and factors.

“We do not have a qualitative research approach, because all are related to our ESG Engine, where we have the input from all the leading ESG data vendors, we have a proprietary algorithm to come up with certain ESG investment signals. This is the key, we define our ESG capabilities, we have many data series which gives us a really good insight into the SDG figures,” Plein explained.

Its proprietary business application, ESG Engine, collects data from 13,000 issuers and integrate ESG factors into the investment processes. It derives ESG signals to quantify and qualify ESG risks and opportunities. That information is supplemented with a variety of raw ESG information provided by third party vendors.

DWS purchases ESG information from five ESG vendors. As of now DWS contracts with ISS-ESG (formerly known as Oekom/Ethics; sector tests, norm tests, ESG ratings, climate transition risk, water risk, green bonds), MSCI ESG (sector tests, norm tests, ESG ratings, climate transition risk, water risk), Morningstar Sustainalytics (norm tests, ESG ratings; for funds: sector tests, norm tests, ESG ratings), S&P TruCost (sector tests, climate transition risk, water risk), and Arabesque S-Ray (sector tests, norm tests, ESG ratings, climate transition risk, water risk).

Its ESG methodology and implementation is owned by the ESG Engine team under the control of the EMP (ESG methodology panel; reporting into the chief investment officer for sustainably investments), which meets weekly.  This includes as well considerations on on- and off-boarding of new data vendors (usually driven from client demand and market standards, regulatory requirements).

The ESG Engine produces ESG signals for liquid securities in corporate and sovereign fixed income, equites, listed real estate, funds and ETFs (but excludes commodities and alternatives). It supports solutions in the active as well as passive mandates.

Using this information, DWS can create customised products around ESG themes and enable portfolio managers to assess sustainability risks and make more informed decisions. In all of its ESG products, the strategy is aligned with the ESG minimum standards.

COVID-19 is the first test of ESG strategies

Plein views the ongoing COVID-19 pandemic as the “first live test” of ESG strategies as many don't have a track record of more than five years.

He commented: “We have seen across all asset classes and products, ESG strategies have performed better than the entire market. We have seen many high quality ESG business models that have superior balance sheets and sustainable cash flows. And this was helping on the downside. We have to bear in mind that ESG funds combine fundamental analysis with an ESG overlay. And how strict or loose your ESG filter is will show how good the performance in the end is.”

“Studies we have seen over time show that ESG could not cause any underperformance in the portfolio in certain asset classes. In the mid to long term, on a risk adjusted basis ESG strategies could not give you a disadvantage against a traditional strategy,” he added.

He also observed that in comparison to the typical retail clients, private wealth management or high net worth individuals have a greater demand to see the level of impact from their strategy. They would also like to see certain financial performance and positive concrete impact. And they demand KPI reporting which shows them on at least a quarterly basis, impact being achieved by the strategy. A report that is transparent, robust and driven by series data.