UBS Asset Management: Thinking holistically about the ESG investment opportunity

This article is sponsored by UBS Asset Management

Private markets investors and managers are focused on ESG as never before, but treating the E, S and G as separate entities may mean neglecting one in favor of another, leading to unintended and unwanted consequences, says Darren Rabenou, head of food & agriculture and ESG investment strategies, at UBS Asset Management, Real Estate & Private Markets. He explains to PERE how the manager is thinking holistically about the ESG investment opportunities in private markets and the challenges in regulating the sector to create practical sustainability regimes worldwide.

How has the approach of institutional investors toward ESG changed recently?

There is a dramatic change happening in real estate in terms of tenants’ and investors’ demand for green buildings in the post-pandemic era. That’s being driven by several factors, but an important one is the demand from young professionals who want to work in healthy and energy-efficient space, in state-of-the-art buildings. Companies are going to use that as a competitive advantage. Investors will focus now on a building’s carbon footprint and associated operating cost and capital expenditure risks.

In many ways, some of the technology firms, which made the work environment a cool place to be in, changed the conversation about the office and the office environment. The best buildings in this regard are getting premium rents and that will be a catalyst for new building development. Not that long ago, investors would ask about what ESG premium they had to pay, as if it was a penalty of some sort. Now, they see there’s a growth opportunity here.

Is the opportunity limited to new developments? Or is there a niche for making older buildings more sustainable?

There is certainly an opportunity for refurbishing and refreshing older buildings in a variety of sectors, even in industrial buildings, to make them more sustainable and to extend their life.

For example, we see a great opportunity in cold storage. Our involvement in agriculture gives us a good insight into the food sector and how changing habits are increasing demand for fresh food and, therefore, cold storage. Yet in the US the average cold storage building is 30-40 years old, so there’s a need for a replacement cycle, which will improve the energy-efficiency of these buildings. And the whole thesis of cold storage, for example, is about reducing food waste, which means less water usage. So, this is a theme that investors are going to be attracted to. It’s not just a question of picking a building and making it ‘greener,’ but integrating your strategy with wider social and economic trends.

How important is it to be able to quantify the benefits of ESG measures?

We need measurable goals across ESG. One of the biggest risks is ‘greenwashing,’ which regulators here in the US have begun to focus on and is an issue that’s getting attention.

Managers that make statements about ESG performance need to back it up. We’ve been a long-time participant in GRESB since 2012. It’s something that we have been very sensitive to and take a lot of pride in. However, it’s not just a question of measurement, but of implementing strategies which make intuitive sense.

For example, using cold storage and delivery of fresh food means less is wasted because it’s not lying unpacked in a market. It is difficult to measure that, but it is intuitively clear to consumers that if, say, salad leaves go direct to them from the warehouse, they have a few days extra shelf life.

Measuring performance is important, but it’s not everything. Data integrity is important, but the problem with data is that you can manipulate data just as easily as you can manipulate a qualitative statement. Therefore, avoiding greenwashing is not just about being 100 percent numbers dependent.

How much do you focus on the ‘S’ in ESG, compared with the ‘E’?

European investors are typically much more focused today on the environmental aspects of ESG compared with their US counterparts, who look more at the social side. Obviously, both the ‘E’ and the ‘S’ are important; you can’t think about them separately. For example, people talk about the benefits of wind power as clean renewable energy, but it is intermittent and expensive. So, what are the social consequences of having expensive power?

Those are the types of consequences we need to address. People look at the environmental impact of alternative energies and the positives, but they haven’t considered the unintended consequence for society, such as the potential for an increase in energy costs that many consumers would find difficult to afford. Being involved in our food and agricultural business, I hear people say that the US should only produce organic food. However, that would mean we’d produce less food and more expensive food. That has a terrible impact on the poorest people.

Similarly, if you make residential developments and luxury apartments so expensive that small firms can’t take space there, then you’re hampering economic growth because 80 percent of US businesses are small businesses; they cannot afford prime office space. These are issues that need to be better understood. Real estate investors are not necessarily investing just in fancy office buildings but making investments directly into communities.

There are opportunities in underinvested communities. Revitalizing an underinvested district has a demonstrable impact on values, on economic activities, on schools as well as providing positive returns. There is a balancing act for investors that need to make a return on capital, but also a positive impact on the areas they invest in. And there is a need for government involvement and public-private cooperation to make these projects work.

We are not an active investor in opportunity zones in the US, but this is an example of an initiative drawing capital into areas that historically have had a difficult time attracting it. Investors are thinking about it from a social impact perspective, not just because it’s a cheap place to come and invest and the government is offering subsidies to do it.

Will technology make buildings’ sustainability cheaper over time?

Technology is coming into its own in real estate and it’s not just about making buildings more energy efficient or saving water, but the whole real estate ecosystem. As a global investor, we are looking at new technology across our entire portfolio, across lots of different sectors. It allows us to identify new opportunities to improve sustainability and productivity from the construction phase through to the asset management, which is very people-intensive.

Looking ahead, what role can private institutional investors play to improve global sustainability? 

Private institutional investors have an important role in encouraging ESG best practice. For example, if you invest in a listed company’s shares, you’ll be a minority investor with a liquid position. And if you do not like their ESG policy, you can sell. As a private investor in a company or fund, you’re locked in. But private investors also tend to have a controlling interest and are, therefore, in a position to drive change.

Private markets investing, whether it’s private equity, infrastructure or real estate can really play an important role in getting investors exposed to ESG-related issues. In fact, there’s a real possibility that ESG evolves into its own asset class. It would attract capital, reduce the incentive for greenwashing and allow for specialization.

Instead of a generalist real estate firm trying to ‘green’ its portfolio with gardens on top of their buildings, investors would commit capital to projects that are 100 percent green and measurably so. That would lead to investment in better ideas rather than diluted ones.

How do you see the ESG regulatory environment for global investors?

The problem is that most of the world is not on the same page as each region has its own regulatory requirements. Firms are trying to broadly align to the UN Sustainable Development Goals (SDGs) and net-zero initiatives, but there is a host of local regulations to keep on top off as well.

Nobody really understands what the rules are, and people keep redefining those rules. The rules of engagement are being defined very differently in different markets. So, regulators need to find the balance between practical measures and encouraging change.

However, European regulators seem to be doing well with setting standards, such as the Sustainable Finance Disclosure Regulation (SFDR) and Taxonomy.

ESG measures must be manageable too. Hiring consultants across the board, just to make sure you’re ticking the boxes, is not only inefficient, but expensive. Regulations must encourage the right sort of behavior, but not make it cost prohibitive by virtue of the action they require, or by being too complex.

For global investors, especially long-term investors in private markets, clear ESG rules are needed because if you’re building long-term assets, you need a reliable future.