Despite the conversation around ESG investing becoming more polarised and politicised, leading some investment managers to renege their commitments on things such as sustainability and diversity, equity and inclusion (DEI) initiatives, others are doubling down on the perceived benefits of ESG impact.
Here, Uma Moriarty, senior investment strategist and head of sustainability at CenterSquare, discusses the firm’s investment strategy and stock selection process, with the belief that within a curated universe of global REIT stocks, there is a premium in taking positions where ESG impact credentials are strong.
Could you talk me through CenterSquare’s investment strategy and why you’re emphasising ESG while some of your peer group are walking away from it altogether?
The way we have always structured how we think about ESG factors within the public market is grounded in a quantitative research approach. We’re real estate specialists, so all of the underlying metrics that we look at are based on what we deem to be material for better real estate performance.
From the environmental side, the built environment is responsible for about 40% of end-use carbon emissions around the world. You can’t really discuss decarbonisation without real estate being part of the equation. So, there are a lot of tenant decisions being made around our emissions targets, and how we can leverage the office and industrial real estate that we lease to achieve those targets. All of these commercial real estate property types are being driven, from a demand perspective, based on how tenants are looking at their carbon emissions and targets, which drives better operating results and better performance. These are the kinds of underlying metrics, from an ESG perspective, that allow us to be rooted in financial materiality in the real estate sector.
We have a massive database of ESG KPIs that we measure quantitatively, and we can back-test them, looking at how these different factors are priced in the market and whether there is efficacy in using ESG as a factor within the marketplace to discover mispricing and alpha-generating opportunities. That’s the mentality through which we’ve developed the ESG scores that we have in our listed real estate business.
What does the screening and the stock selection process look like?
For the ESG Impact strategy in particular, not only does it take those underlying ESG factors, but it also overlays an impact component from a listed real estate perspective, aligned with the UN Sustainable Development Goals (UN SDGs). We went through all 17 goals and narrowed them down to ones that are both material for real estate and are part of what the global listed real estate universe does. From there, we identified seven different goals with eight underlying metrics that we were able to define and quantify to identify companies that are making a positive impact towards achieving the UN SDGs, using these specific quantitative metrics.
Essentially, for this strategy, we take the global listed real estate investable universe of around 360 stocks, and focus specifically on the top third of ESG scores based on our assessments. From there, we apply an impact assessment to identify companies that are making a positive impact on at least one of the different metrics that we’ve identified. Putting those two pieces together effectively screens our investable universe for this strategy.
That being said, we’re measuring success for the strategy versus just the global real estate benchmark, not a customised green benchmark or a sustainability benchmark. The purpose of this is to demonstrate that, through an ESG and an impact lens, you can generate alpha just in the market.
We launched the strategy last year in April, and it has generated a really strong year for us. We did a tonne of back testing with it prior to launch, and we’ve been able to prove the Alpha generation capabilities of ESG and impact as factors within the global listed real estate universe.
Thinking about that impact, is it more to do with adaptation or mitigation, or is it a combination of the two?
A combination of the two. There are a couple of factors that are environmental, and a couple that are social.
On the environmental side, we’re looking at things like the circular economy and we’re also thinking about climate action in terms of how we think about energy use, greenhouse gas emissions, water usage, etc. within the underlying portfolios, and how companies are managing the types of resources that are being used across the real estate industry. On the social side, we’re looking at a couple of different things, one being gender equality, especially in management across these companies, as well as the diversity of the workforce.
Within the investable universe that we have left after our screening process, though, we’re running the same fundamental real estate investment strategy that we have run for 30 years at CenterSquare, rooted in being able to generate that consistent performance. We’re just deploying that investment strategy in a slightly different lens.
What challenges have you encountered investing in this way, and how have you overcome them?
Because of the screening process that we’ve put in place, it by default is reducing our investable universe, and from there, as I mentioned, we deploy our fundamental real estate investment process. Within that, you have to figure out a way to effectively create a portfolio that has the right types of exposures to other factors within the market. That way, you’re creating a balanced portfolio and you’re mitigating risk appropriately.
For example, in the US, you have a sector like the net lease sector, which is effectively a bond proxy and so it tends to be a safety trade. Unfortunately, the net lease sector is also a difficult business model to generate a lot of positive environmental impact from at the property level because they have no control of what’s happening at the asset level despite signing 30-year leases. So, it’s very difficult for them to amend those leases to create green leasing structures that have access to underlying data from the properties. Their environmental performance, therefore, typically tends to lag behind other leasing structures within the REIT space, and so, you don’t typically have a tonne of traditional net lease companies that you can invest in if you’re trying to invest in the best in class ESG names. You then have to find that factor exposure elsewhere.
CenterSquare has investments across private equity, private debt and listed equity. How do those strategies help compliment one another?
It allows us to do a lot of cross-pollination in terms of ideas and information. A big part of why our underlying ESG models that we use in the listed real estate space are so great is because we have experience actually owning and operating real estate assets, which brings a completely different point of view to assessing the impact from a financial perspective, from a social perspective and from an environmental perspective, and that provides us with a really unique view.
One of the current trends in sustainable investing is an increase in emphasis on private market investments. Given the cross-pollination of ideas and information across your private and listed strategies, would you agree there needs to be more discussion about balance and diversification?
Absolutely. We have this conversation frequently with our clients, because a lot of times our clients are invested in real estate, both on the public and private side.
One of the interesting things that I don’t think people necessarily appreciate about investing in real estate in the listed market, especially from an ESG or an impact perspective, is the scope of impact that you can have in the REIT market compared to a single asset is vastly different. If you’re partnering with an investment management firm that is an active investor, that can engage with companies and can speak with their capital, you can have conversations around investing capital toward reducing carbon emissions. If you invest in a single real estate asset, you are investing in a single real estate asset to try and create that impact, but if you invest in a REIT, the magnitude and the scaling of your incremental dollar is significantly larger because it’s on a global scale, it’s on a large platform and it’s on a large portfolio of assets.
The capacity of investing in real estate with a public market lens, from an impact and ESG perspective, just scales an individual investment to being so much bigger. That’s one of the conversations we’ve been having with a lot of folks, in terms of why we do ESG or impact in real estate in the public markets versus in the private markets, and it’s just the scalability of your impact.
