Making ESG a Reality in the World of Commodities
To make commodity investment work in an ESG-centered world, one needs to see the whole picture
Demand for ESG investment products is growing across the globe and isn’t stopping. A recent survey of asset managers showed they expect their portfolios to be more than 40% ESG in the next five years.
From a commodities investment standpoint, we must ask ourselves: How do commodities fit in? Commodities are part of the reason why we're in the situation we are today in terms of carbon emissions, pollution from driving, jet fuel and other things.
But let’s be realistic: we're surrounded by commodities. We will continue to consume commodities as the global population grows and as global GDP grows. And in particular, commodities will be a focus as new policies are enacted to restructure investments from a greener standpoint.
And commodities are actually part of the solution.
Commodities, the raw materials that make up our physical and commercial world, are a central source of investments and present ESG-minded investors with a conundrum: how to measure, rank and use commodities to invest with an ESG-focused strategy.
Societe Generale has implemented ESG ratings within its equity research offering and we didn’t want to back down from the challenge of doing the same for commodities.
But in order to look at and rank commodities from an ESG perspective – and here, we’re speaking just of the Environmental and Social aspects of ESG – we needed to look at the whole picture. A commodity’s standing within ESG needs to be looked at holistically. Simply looking at one metric, such as carbon emissions, doesn’t provide the whole picture.
Take for example, metals. Mining and forging metals emits carbon and from a carbon emissions standpoint alone would boot metals from an ESG portfolio. But not all metals are the same throughout their life cycle. Some metals emit more carbon than others but may live a longer life and be used for ESG-related purposes.
For example, building wind turbines and solar panels requires massive amounts of commodities, specifically metal. There are many industrial variables that we confront when we set about working on renewable energy. As an illustration, the amount of copper used in offshore wind farms is four times the amount that's used in onshore wind farms. So, while copper may rank very low in a purely emissions ranking, when looked at holistically, it ranks much better from an ESG perspective.
At Societe Generale, we wanted to make this holistic approach a reality, so we set out to get a good measurement of commodity investing from an ESG perspective and then constructed an investment strategy around that. We needed to see how an ESG-focused holistic commodity strategy would work in the real world. First, we partnered with the consulting group RFU which has for decades evaluated ESG from multiple perspectives. We then worked with them to develop a ranking mechanism for commodities. This ranking focused on the entire value chain including production and utilizations as well as a cradle-to-grave approach that includes logistics and recycling.
Once looked at holistically, we end up with a better picture of how commodities rank within the ESG sphere.
To develop an investment strategy, we started with the well-known benchmark index, the BCOM index, and worked out a formula to modify its weights on each commodity to make it less negatively ESG driven compared to the rankings developed with RFU. Back tested to 2007, this strategy not only improved the performance of the index, but also made it less ESG negative.
With the burgeoning panoply of ESG-driven indexes and products, our way is not the only way. But we’ve demonstrated that in order to make ESG a reality in the world of commodities, a holistic approach that examines the entirety of the commodity is the way forward.
Michael Haigh is Managing Director and Global Head of Commodities Research for Societe Generale.
Nathanael Bienvenu is Head of Equity Derivatives Financial Engineering for the Americas for Societe Generale.
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