Analysis: Strategies for Responsible Investments
There are several strategies for an organisation implementing responsible investments. The choice of strategy can depend on how the asset class functions, market dynamics, company preferences engagement, or other factors. Commonly, seven different strategies for responsible investments are recognised.
Exclusion means that an investor excludes specific parts of the available investment universe. It could concern individual companies, industry sectors or countries that are excluded based on different criteria. Entropics excludes bonds based on the underlying insurance purpose and has identified the following main criteria for exclusion in the policy for responsible investments:
- Manufacturing, distribution or marketing of harmful tobacco products
- Manufacturing, distribution or marketing of alcohol
- Manufacturing, distribution or marketing of pornography
- Manufacturing, distribution or marketing of military equipment
- Extraction or unnecessarily extensive use of fossil fuels
These main criteria are used in a combination with an over-arching criterion that cat bonds should provide societal benefits.
Norms based screening
This method means that investments are scrutinized based on how well they comply with international standards or norms. The investor can decide which norms to base the screening on, but commonly norms established by international organizations, such as the UN, are used. Entropics applies norms based screening to a certain extent, based on general principles in international law. We apply the following criteria when analysing companies seeking insurance protection through cat bonds:
- Do not violate fundamental human rights
- Do not knowingly harm the local population or undermine democratic processes or the rule of law
- Do not knowingly harm the environment or harm people’s health
- Do not make use of corruption and bribery
Integration of ESG factors in the traditional financial analysis is done through quantification of ESG factors and a focus on the possible impact of these factors (positively as well as negatively). Examples could be that a company with high dependence on fossil fuels is economically sensitive to the introduction of emission trading, or that a solar cell manufacturer benefits from energy system transition. Due to the structure of cat bonds, ESG integration is of small or no use for a cat bond manager.
Engagement and voting
The strategy means that an investor does not necessarily refrain from investing, but uses the right to influence as a shareholder through direct engagement with companies or by participating at shareholders’ meetings. The long-term intent is to influence companies to make improvements. As cat bonds are basically corporate bonds, the opportunity to do so for a manager is highly limited. Within the larger field of collateralised reinsurance, where transactions can be agreed among a limited number of managers and an issuer, this may be more of an opportunity. As Entropics currently only manages liquid cat bonds, this opportunity is not relevant.
“Best in class”
Seeking “best in class” investments means that a manager chooses or weights investments based on ESG criteria, where high scores cause prioritization of certain investments. The basis for this selection can vary, such as best overall, largest change or best sector. At present, the supply of cat bonds is too small to enable this strategy combined with diversification.
Impact investments are made to generate financial returns as well as social or ecological impact. Often, investors are prepared to abstain some financial return, provided that the total return (financial and other goods) is good enough.
Thematic sustainable investments
Thematic funds focus on investments with either a broad ESG focus or focused on certain ESG indicators. The intent is that investments should contribute to strengthening actors that contribute to solving climate gas emissions, eco-efficiency or public health, to mention a few examples. The cat bond market is at present too small with too small supply of thematic bonds to enable this strategy.