Big Read: Brazilian asset managers’ big ESG challenge

Renato Eid, head of beta strategies and ESG Integration at Itaú Asset Management, does not appear surprised to be sitting down with Responsible Investor.

As Eid settles into the São Paulo meeting room, whose sci-fi-inspired windows seem to be used as the backdrop for at least 50 percent of Brazilian car commercials, he ties the interview into the general increase in ESG activity in the country since the pandemic.

And, by activity, he clearly means “noise” rather than “action”.

“We’ve experienced a large boom in ESG in Brazil since 2020 – suddenly all asset managers are aware of ESG, and many claim to have been doing ESG since the Earth became the Earth,” he says, a little weary of the encroachment on an investment approach that Itaú has a demonstrable track record on all the way back to 2004 – an impressive pedigree in Latin America.

“Journalists have started chasing ESG coverage and it seems like everyone is saying they have been doing it for a long time – somehow everyone is now an ESG expert – but when you look closely a lot of this is kind of, you know, fragile speech.”

However, Itaú Asset Management’s credentials check out. In 2004, the manager – the investment management division of Itaú Unibanco group – launched Fundo Itaú Excelência Social (FIES), one of the first Brazilian ESG funds, whose main characteristic was to invest in shares of companies with better sustainability performance.

Then in 2008, Itaú AM became the first major investment manager in Brazil to join the Principles for Responsible Investment (PRI).

It developed internal capability to estimate the financial impact of ESG issues for each investee company, and subsequently its own valuation models, which Eid stresses continue to improve given the “dynamic characteristics of the ESG industry”.

ESG integration

Itaú AM started publishing ESG integration models for fixed income and variable income in 2013 and 2014 respectively.

In 2016, it signed up to the stewardship code developed by Amec, an industry body for institutional investors active in Brazil. The code’s principles and guidelines aim to encourage, among other actions, the evaluation of ESG aspects by investors and the exercise of voting rights in shareholder meetings.

“Suddenly all asset managers are aware of ESG, and many claim to have been doing ESG since the Earth became the earth”

Renato Eid

 

Itaú AM has taken its commitments seriously. “We publish our AGM votes on our website, and I challenge you to find another Brazilian [asset management company] that does that,” says Eid.

“We also have a strong governance role for ESG – for example, we [ESG professionals] are members of the credit committee and we have veto power. And it’s not only for the ESG funds – it’s for all funds.”

Itaú’s proprietary ESG assessment models, which cover 99.8 percent of its assets under management, consider the climate issue as one of the key elements of analysis, along with seven other environmental and social themes. The outputs of these models are then used to drive investment strategy and product development.

Eid says his approach for evolving the ESG agenda is dominated by caution. Once the company moves its ESG frontier forward “it’s impossible to get back”, he adds, noting that rash moves can leave the company open to accusations of greenwashing or gimmicky investments.

“If we say something, we need to be able to prove it,” he says. “It’s not just about arranging words.”

Such a measured approach is probably why he views today’s market hype around ESG in Brazil with a generous dollop of scepticism.

“We are very cautious about every step that we make because we need to protect our customer, our brand, and our ecosystem,” he says. “[The ESG boom] is good because it helps to spread awareness about the theme. But at the same time, we also see it as fragile because the narrative is not yet built on a sustainable structure. I guess it’s a balance between going mainstream and greenwashing.”

Limited liquidity

Part of Eid’s wariness about the proliferation of ESG strategies in Brazil is that it has yet to lead to capital reallocation to sustainable investments.

There is an obvious reason for this lack of liquidity in ESG products: Brazil’s sky-high nominal interest rates. The country’s base rate, the Selic, was hiked to 13.75 percent in August 2022 following a very steep tightening cycle.

“Most of our ESG strategies are connected to the equity space and no one really cares about equities when interest rates are nearly 14 percent,” says Eid.

But what about Itaú’s fixed income investment funds – surely they have seen money coming in?

“Not really,” says Alexandre Gazzotti, senior ESG Analyst at Itaú AM. “We do have a strategy that invests in companies that promote external positives, such as healthcare companies, homebuilders, education companies and sanitation. It’s not an impact fund but it’s part of our ESG product suite.

“We’ve seen a little bit of traction with this fund – more than we’ve seen with the equity funds – but it’s far from as big as it could be.”

What explains the lack of enthusiasm? “I think we need to promote education, promote the product, explain how it can fit into [broader] investment strategies,” says Gazzotti.

The level of Selic, and thus the risk-free rate, is a culprit here too. And ESG funds suffer by comparison with those related to real estate, agriculture and infrastructure, which offer tax-free incentives for those investors that do want to pick up a spread over the sovereign benchmark.

International investors

But surely international investors will be keen to add Brazilian ESG exposure at these rates?

“We’ve recently seen a downward trend in the Brazilian real against the dollar and no one wants to catch the falling knife,” says Eid. “But we’ve just seen the start of a new monetary cycle [the Brazilian Central Bank cut Selic by 50bps in August] and we’re seeing the start of new interest in talking about diversification – and ESG products as part of that.

“In this conversation we’re being asked about our shelf of products in the ESG space – thematic and broad strategies.”

Eid believes these broad strategies, which embed ESG through the asset manager’s entire suite of funds, are the best way to ensure it has the greatest impact.

“We’ve developed a proprietary model to integrate ESG throughout the investment process – which means calibrating and innovating, as well as disseminating the information and intelligence that we produce among all or our portfolio managers,” he says.

“As a large asset manager, we can use all of our power to move the ESG agenda through a strategy of integration. Instead of just having two or three products covering a theme, we build a consensus internally.”

Such an approach is inherently more difficult. Not only does the ESG perspective often clash with individual portfolio manager’s different investment horizons – it is also, Gazzotti acknowledges, less “catchy” for the investment community than the thematic approach.

“If you had to choose one approach – the integrated or thematic approach – then it’s much more powerful to do the integration,” says Gazzotti. “But it’s also helpful to useful thematic approaches as well. We can ask clients. ‘Do you want to invest in hydrogen?’ And it’s a very clear and straightforward proposition.”

Hydrogen focus

In July, Itaú AM launched a hydrogen ETF (YDRO11) comprised of 19 companies specialising in the production, storage and transport of hydrogen and in the design and manufacture of fuel cells.

Such ETFs that offer investment exposure to the decarbonisation theme create opportunities for the company to begin ESG conversations in a manner that is often easier than discussing broad, integrated strategies, says Eid.

“Carbon isn’t quite there yet, but hydrogen we can tackle. We have an investment thesis”

Renato Eid

He is analysing the possibility of an ETF based on companies involved in the sequestration and capture of carbon in the near future.

“Carbon isn’t quite there yet – but hydrogen we can tackle,” Eid says. “Hydrogen is feasible. We have an investment thesis. It’s clear that hydrogen is one of the new energy resources that should be considered to replace fossil fuels.

“Five years ago, it would have been impossible to build a dedicated hydrogen ETF because there wasn’t an economic reason to have such a strategy.”

Nevertheless, launching new products is still a delicate balance between economic rationale and creating sufficient demand.

Using the hydrogen ETF as an example, Gazzotti says building the investor base for such new products requires convincing clients of the longer-term merits of the investment, given that these are not short-term bets.

“Investors need a long investment horizon to enter these funds,” he says. “There’s a lot that needs to be developed, in terms in lowering costs and promoting the broader hydrogen eco-system.”

Brazilian ecosystem

Meanwhile, the wider ESG ecosystem is slowly developing in Brazil.

Professional bodies such as the country’s banking association, Anbima, and the securities regulator, CVM, are using the work on taxonomy and other sustainable market structures that have been developed in Europe.

Eid has been an active participant in efforts by Anbima to introduce market standards, and says using the foundational principles developed in the EU makes sense.

“From a taxonomy point of view, we don’t want to reinvent the wheel,” he says. “So we are using what has already been developed as a kind of inspiration. Having said that, our challenge in Brazil is completely different, and so the solutions must be completely different.”

As an example, Eid points to sanitation companies. In Brazil, half the population does not have access to sanitation so the financing needs of these companies are huge, and the improved services have a huge and direct impact on both society and the environment.

“Some industries are at different stages of development, so maybe there needs to be differences in taxonomies [that apply to financing these companies],” says Eid. “Fortunately, the CVM and Anbima are very aligned in terms of their vision of the regulatory stance concerning ESG products.”

Tipping point

At the same time as the tegulators have been creating the rules of ESG engagement, Eid and his team at Itaú AM have been building a platform to be ready for the capital flows that he is still confident will materialise.

“I think international institutional investors are starting to look for ways to fill the gaps and promote ESG financing in other geographies, because their investors are asking them what they are doing with their money,” he says.

“The main issue is how we build the pipes that connect that interest, that funnel the money to projects. Because the willingness to make [ESG-driven] change happen since Paris is there.”

Eid sees global finance shifting to his perspective on integration. “In the future, it won’t be natural to talk about a company’s financials, then to talk about their ESG issues,” he says. “It will be the same conversation.

“We are still very, very far from that, and – despite Itaú being ahead of the curve – we are still very humble in recognising that we are far away from where we will reach in terms of ESG intel, information, transparency, and what it means to have these embedded in a genuine way.”

“Clients want returns to look after their children, but they also want to be able to go outside and it not to be 50C”

Renato Eid

While Eid is challenging Itaú to continue to evolve, he clearly feels he has created a competitive advantage in terms of positioning the company as a leading ESG asset manager for inward capital flows.

But he is also optimistic that local investors will embrace ESG – not just as a cyclical opportunity as Selic starts to fall again, but in terms of a structural shift that he believes will materialise over the coming decade.

“We used to separate the personas of the investor – the investor and the human,” says Eid. “The investor was focused on returns and the human was interested in their purpose in society.

“This is evolving and these personas are getting closer, combining into one. So clients want returns to look after their children, but they also want to be able to go outside and it not be 50C,” he continues.

“Investors are realising there is something much bigger than just returns, something much bigger than a three-month investment horizon.”