Investing to save the world

Written by: Andrew Strange Posted: 21/05/2018

BL56_ESG illoEthical investing was always something of a niche market but the landscape has changed dramatically, with investors demanding better governance from big businesses 

For decades, ethical and socially responsible investing only appealed to a handful of investors – partly because it generally didn’t deliver the returns of mainstream investments. But the times they are a-changing. The financial crisis shone a harsh spotlight on corporate governance, with investors calling for higher standards all round from the businesses they put their money in. 

This coincided with the rise of a new generation beginning to flex their muscles in the markets. The millennials – those born between the early 1980s and 2000 – are demanding that firms be far more socially responsible, and are putting their money where their hearts are.

And the figures seem hard to refute. The value of assets managed under the UN Principles of Responsible Investment increased from $6.5 trillion in 2006 to $62 trillion at the end of 2016. 

The millennials have arguably become the standard bearers of responsible investing and, with their wealth predicted to rise to $24 trillion by 2020, their impact will continue to be felt. 

But they’re not alone. Families aiming to leave the planet in good shape for their children and grandchildren are also looking to the sector – while charities, foundations and pension funds are increasingly introducing socially responsible criteria to their investment policies. 

Changing priorities

When 100 Jersey investors were canvassed at a forum held by UBS on the island recently, 72 per cent said they were interested in investing in impact or sustainable investments this year, while 64 per cent believed those investments would generate similar returns to a traditional portfolio.

And as society’s priorities, such as energy efficiency and healthy foods, become more closely aligned with those of investors, there’s growing evidence that these funds can offer good returns.

The most basic responsible investment strategies emerged in the 1960s, when faith organisations began screening out companies involved in sectors such as the arms industry, tobacco, alcohol, gambling and pornography. But the sector has been turbo charged by more recent approaches. 

Impact investing, for example, focuses capital on companies that bring benefits to society, as well as environmental, social and governance (ESG) integration, which allows asset managers to include ESG factors in their financial analysis.

According to Patrick Thomas, Investment Manager at Canaccord Genuity Wealth Management, the data on the effect of exclusion strategies and impact investing is mixed. Exciting companies sometimes fail to take the commercial actions to sustain the business, so for every Tesla, there’s a Drax. The value of shares in the North Yorkshire coal-fired power station has more than halved since its 2015 decision to abandon plans to introduce carbon capture technology that would reduce emissions.

But there’s mounting evidence that ESG scoring, which ranks companies on such issues as the way they manage environmental issues or treat their staff, can highlight strong management, which is good for investors. 

Thomas explains: “I think we have enough data now to draw some pretty firm conclusions about ESG. It’s our view that thinking seriously about ESG factors is going to help companies achieve sustainable competitive advantages.”

In fact, if you compare the S&P 500 index with the MSCI KLD 400, a comparable index which gives investors exposure to companies with positive ESG scores, the latter shows a slightly higher average annual return, although it’s also slightly more volatile. 

Fund focus

With £3bn under management, Liontrust’s Sustainable Growth Funds are examples of funds that invest in companies considered to be making a positive impact on society. They screen out ‘sin stocks’ and focus on those that fit within three key themes the firm believes meet the ethical concerns of investors and offer long-term growth potential – efficiency, health and quality of life, and safety and resilience. 

While these are vibrant areas of today’s economy, careful analysis of the fundamentals of each company remains an important part of the process. This has seen the funds invest in, for example, ARM Technologies, which makes extremely energy-efficient chips for use in mobile phones, and Equinix, an energy-efficient server farm provider. 

Peter Michaelis, Head of Sustainable Investment at Liontrust, says: “We’ve also long been looking for companies that provide food that doesn’t kill us, because of the epidemic of obesity, leading to diabetes, low quality of life and premature death. 

“So, we’ve invested in those companies that provide healthier food and we’ve seen massive growth – growth that’s three times stronger than conventional food producers. You only need to look down your supermarket aisles these days to see how much is given over to ‘free-from’ ingredients, herbal teas and rice cakes.”

He adds: “We’ve been running these funds for more than a decade, and last year every single fund was top quartile and we’re comparing ourselves with mainstream funds. Every single fund outperformed over three years and five years. We’ve just gone over £3bn of assets in these funds. They started in 2001 and I think last year was our strongest year ever in terms of new business.” 

Philanthropic approach

Traditionally, wealthy families have taken a philanthropic approach to improving society, often making donations through a family foundation. But as responsible and impact investing become more sophisticated could we see them switch their approach to investing instead? 

Rob Broughton, Director, Senior Client Adviser at UBS Wealth Management, believes we’re likely to see an increase in these foundations investing in a sustainable way and then giving the returns to good causes, which means the money is used to benefit society twice.

The market for ESG funds is becoming more mature. According to Philip Radford, Director at Saffery Champness, while growth was once driven by fund providers creating products to sell on the back of growing social awareness, client demand has become by far the most important factor. As a result, companies have had to develop a great deal of expertise in order to meet that demand. 

“Now, certainly with what we do for clients and what we hear from other people in this area and consultants that we speak with, people are more intelligent in the way that they approach this kind of investing,” he explains. “They’re asking much more complex questions and therefore the providers of the products really have to have substance around them.”

That said, much of the recent growth has taken place in a bull market and it remains to be seen whether investors will stick to their principles if the markets take a dive.

As Rob Broughton explains: “In that situation, people might look to impact investing more than traditional strategies because responsible investing is a very liquid investment universe now and we think it’s unlikely people will head for the door. What you tend to find is that when you see big corrections, it’s the instruments and assets that are less liquid that have the biggest problems.”

Whatever happens in the coming years, it’s likely to be the millennials leading the charge. This is a generation that’s determined to make a difference and we’ve already seen responsible investments grow dramatically. So who can tell where they will take us next?

Predicting BP’s Deepwater Horizon disaster

Environmental, social and governance (ESG) factors are used by socially conscious investors to screen companies by their performance in those three areas. These criteria can be applied to every sector, rather than just those traditionally thought of as socially responsible. So, for example, someone wanting to invest in an oil company could see which ones have the best ESG score.
   Astute ESG investors would have avoided BP before the Deepwater Horizon disaster in the Gulf of Mexico. Two years earlier, the company faced severe criticism for its performance on environmental pollution, occupational health and safety issues, labour and its impact on local communities. And in 2005, MSCI suspended BP from its sustainable equity indices after the Texas City explosion.
   As the Deepwater Horizon catastrophe unfolded in 2010, 50 per cent was wiped off BP’s share price – and in the wake of the disaster, a peer group of major oil companies lost 18.5 per cent. Since then, BP’s share price has underperformed the peer group by around 37 per cent. 

 


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