To make ESG investing work, Swiss Re focuses on diversity

ShutterstockSergey Nivens
Asset managers should shift their perspective to diverse ESG options.

Swiss Re, the world’s second-largest reinsurer, is 90 percent of the way through the process of shifting its entire $130 billion liquid asset portfolio towards environmental, social and corporate governance (ESG) indices. It expects to complete the transition by the end of the third quarter of 2017.

The $595 billion (PDF) global reinsurance industry hedges large risks that fall outside of a regular insurance carrier's capacity, such as underwriting large construction projects. A healthy reinsurance sector, more or less, provides industries from building to shipping to aviation with the security to do business. 

Risk-averse reinsurers's finances are being hit more often by the impact of climate-linked catastrophes, such as floods and hurricanes. That is prompting more frequent conversations in the corporate world around this challenge: How to help mitigate the risks that climate change poses in certain sectors and regions. Swiss Re's decision to tie its portfolio to ESG principles is, at least in part, motivated by a need to stay on top of what companies and sectors are actually doing. 

"Swiss Re is a long-term investor, and we are committed to generating sustainable long-term returns," said Guido Fürer, Swiss Re’s chief investment officer, in a report (PDF) that outlines the reinsurer's decision. 

Other major reinsurers such as Axa, Aviva and Scor also have taken recent action on ethical investing, for example, divesting about $4 billion worth of tobacco stocks by 2017. Unlike them, however, Swiss Re does not plan to divest from any particular industry or company. Instead, it intends to focus on diversifying its portfolio.

Swiss Re claims to be the first reinsurer to base its entire portfolio on ethical principles, using ESG indices compiled by MSCI, a provider of research, benchmarks and tools for institutional investors.

The company selected the MSCI ESG Leaders index for its equity mandates and the Bloomberg Barclays MSCI Corporate Sustainability index for credit. For its asset managers, this is a signal that the global reinsurer only wants to invest in high-performing companies with the best ESG profiles. 

"The implications for corporate executives and money managers are that investors are now determined to integrate ESG principles into their investment processes because it makes economic sense," said Deborah Yang, managing director, head of index, EMEA at MSCI. "And they are likely to do that across all their portfolios, in one stop or over time." 

Rethinking investment

Fürer told the Financial Times that Swiss Re deliberated its move for 18 months before making the decision, which was ultimately greenlit due to the potential financial benefits of ethically based investments, cementing ESG as part of its core investment strategy.

"Motives are … shifting from simply 'doing good' towards achieving a combination of return, risk and sustainability objectives," stated the Swiss Re report. "About three-quarters of institutional investors say that risk mitigation is a driver of their increased interest in ESG."

According to Reuters, the MSCI ESG Leaders Index has gained 11.2 percent in 2017, outperforming the MSCI International World Price Index (an equity benchmark that represents large and mid-cap equity performances across 23 developed market countries), which rose 9.6 percent. 

The shift in investment philosophy is designed to make Swiss Re more resilient and protect investors from market volatility.

What does this mean for asset managers? The Forum for Sustainable and Responsible Investment states that $22.9 trillion (PDF) in global ESG assets are under management, and these stocks have been performing as well as regular indices — with the added benefit of being more stable over time.

Switching to ESG indices in 2008 would have helped investors avoid all but 10 percent of bankruptcies that occurred since then, found (PDF) Bank of America Merrill Lynch. 

Furthermore, said Savita Subramanian, head of U.S. equity and quantitative strategy, Bank of America Merrill Lynch Global Research, "progressive ESG practices make companies less likely to suffer large price declines and signal significantly better three- to five-year returns on equity than their counterparts and a greater chance of long-term success."

"Imagine the impact we can have if long-term investors succeed in fully integrating ESG considerations into our combined $75 trillion in institutional assets," Fürer wrote in the Swiss Re report. "We have a unique opportunity to make the world more resilient."

Beyond 'do no harm'

Swiss Re’s new investing philosophy is built on three pillars:

  1. Switching to broad-based ESG benchmarks, focusing on higher ESG-rated investments; the most important of Swiss Re's new investment strategy

  2. Creating mandates around themes such as green bonds, renewable or social infrastructure

  3. Exclusions based on an internal sustainable risk framework and avoiding thermal coal investments

It also leans on investment performance over time rather than immediate, high yields.

"Our analysis suggests that the main mechanism through which better sustainability translates into better investment performance is not return enhancement, but rather risk reduction," said Philipp Krueger, assistant professor of responsible finance at the University of Geneva, in the Swiss Re report.

The risk-reducing ESG investing space is by no means anathema to innovation, he said: "Very often, people still think that ESG investing is simply this concept of excluding specific assets or entire industries based on ethical, religious or other normative grounds. This might have been true a decade ago but it is a poor description of today’s ESG investing landscape."

Innovation around ESG investing is necessary. Excluding every objectionable firm in an index or selecting only ESG leaders can "slash the number of acceptable stocks by up to half" and prevent opportunities for dialogue and engagement, according to Laura Nishikawa, head of fixed income in ESG research at MSCI.

There still are major hurdles to overcome in the wider adoption of sustainable investing, according to Swiss Re. One is the need for standardized best practices for ESG investors; another is short-term thinking related to the quarterly or semi-annual reporting cycle. The third, which the MSCI addresses, is a lack of suitable ESG-related investment products.

Although reinsurers are heavily exposed to natural catastrophe losses due to climate change, the industry has a long way to go when it comes to widespread adoption of ESG-based investment principles. It is important for one company to lead the way and show increased return as it moves away from investing in emissions-heavy industries, which can both lead to greater instances of climate-related losses and future financial losses from stranded assets.

"Enhancing our investment portfolio by adopting broad-based ESG benchmarks has been the most meaningful and strategic step in our journey to integrate ESG considerations into the investment process," Fürer said.