As the world faces a growing number of freak weather events and natural catastrophes, investors are increasingly taking action writes Hannah Stodell.
Raging fires in the Amazon and Australia, and widespread flooding closer to home this year have been a wake-up call for leaders around the world. These environmental disasters have also prompted some soul searching at an individual level as to what people may have done to contribute to them.
Interest in environmental, social and governance investing (ESG) and ethical investing (see What is ESG? box below) is already high thanks to factors such as the ‘Greta Thunberg effect’, David Attenborough’s Blue Planet series and global government policies to allocate more capital to sustainable investments.
Assets under management in UK ethical funds grew from £10.2 billion in April 2015 to £20 billion in July 2019 according to the Investment Association, the UK’s investment management trade body. And a 2019 survey by the Association found that in 2018, more than a quarter (26%) of the UK’s assets under management were invested using some form of socially responsible criteria.
So, could the latest global events spark an even greater interest in ESG? And in a sea of purported ‘ethical’ funds, how can retail investors ensure their money funds activities that actually benefit the planet for future generations?
What is ESG investing
A company must be managing its environmental impact by reducing carbon emissions, waste and resources such as energy. Environmental factors also include long-term impact and sustainability.
This covers areas such as diversity, inclusion, fair remuneration and impact on the local community and economy through job creation and using local suppliers. Other areas include human rights, consumer protection and the payment of tax.
This includes things like the management structure within the business, how it manages risk and executive remuneration.
While Australia’s recent bushfire crisis has added momentum to the ESG and ethical investment movement, a number of other fundamental drivers are at play, including a generational shift towards more conscious investment approaches, says Paris Jordan, analyst in the Socially Responsible Investing team at Sanlam.
She cites the company’s What’s Your Number? survey, undertaken in 2019, in which six out of 10 people polled said it was important their investments didn’t contravene their beliefs. Among the millennial cohort (25 – 34-yearolds), that figure rose to over 80%. “Millennials are driven by different factors. We know that the majority of money is still with grandparents and parents, but at some point, that isn’t going to be the case,” she says. “Companies that want to survive, particularly investment companies, need to think about how they will cater for, and provide products for, future generations.”
It’s not just millennials; supply and demand is driving growth in the market across generations, according to Jordan, with a greater number of ESG funds and ethical products now available. She adds: “We’ve seen the investment community evolve too, so historically where they were very focused on omission or screening out particular companies, now we have a whole host of different investment approaches to choose from.”
Adopting a range of investment approaches rather than purely screening out so-called sin stocks (from companies in the tobacco, defence and gambling space, for example) can provide better risk-adjusted outcomes, so ethics and profit needn’t be mutually exclusive, explains Philip Smeaton, Chief Investment Officer at Sanlam. “If somebody chooses not to invest in oil and gas, it’s eradicating a lot of investment opportunities,” he says. “If they say, we’ll invest in oil and gas companies, but we’ll identify the ones that have the most sustainable businesses, are investing in the right places and have a management team that is seeking out more environmentally friendly solutions, commercially developing them and making money – that can add value.”
The notion that a socially responsible investment approach means sacrificing returns has also been challenged by a mega study on the relationship between ESG and performance, published in the Journal of Sustainable Finance & Investment. It noted that the large majority of studies – about 90% – report positive findings and a positive impact on investment returns.
Dual-class structures and company accountability
While investors are increasingly using their financial muscle to demand action on environmental and social issues from the companies they invest in, other developments such as the use of dual-class stock structures in company flotations appear to be limiting shareholder rights.
This is a trend that is particularly prevalent among technology businesses, where companies such as Pinterest and Lyft have issued dual-class stock structures in recent IPOs. In both cases, management retained more control through greater voting rights, even after the companies went public. This approach leaves other shareholders less able to hold the management to account on ethical issues.
Although it raises questions about company accountability, the power of activist investors shouldn’t be underestimated, says Sanlam’s Chief Investment Officer Philip Smeaton, pointing to Rio Tinto’s exit from the coal sector in 2018.
“You don’t need to own the whole company to effect change, you just need to have enough shares so that you get a voice, and it only needs one activist to coordinate that,” he says.
Smeaton explains: “ESG is an increasingly important part of investing and we incorporate this into our decision-making framework. We seek to invest in great businesses, and of course to be a great business you have to be sustainable. In 2019 we partnered with Sustainalytics, a global provider of ESG research and ratings, to further incorporate ESG risk analysis into our fundamental research.
“We recognise that some of our clients may have strong but differing ethical beliefs, so where we manage bespoke mandates we can tailor their investments to focus on the companies that best align with their wishes.”
The proliferation of ESG funds in the wider market has not escaped the attention of regulators both in the UK and further afield. In January, the US Securities and Exchange Commission identified ESG investing as an issue for examination in the coming year. The EU is also drawing up a taxonomy that seeks to standardise what sorts of investments can be labelled ‘green’ and the British Standards Institute is drafting its own Publicly Available Specification to help firms establish, implement and manage the process of integrating ESG and sustainability into investment management.
These will not be quick fixes however, and investors wishing to ensure their investments really are green should seek professional advice, says Jordan, who anticipates further growth in ESG and ethical investment in the coming years.