There is a rapidly increasing demand from families for responsible investing in their portfolios, particularly among the ‘next generation’.¹ Families increasingly want their investments to line up with their personal values, and are seeking investment outcomes that are simultaneously financially rewarding and supportive of positive social and environmental change.
To go beyond these good intentions, clients need a clear, robust and responsible investment framework from their portfolio managers. One such approach is known as ‘ESG’ investing: strategies that integrate environmental, social and governance factors into the investment process.
As a first step, ESG investing will look to avoid companies that fail to meet simple standards on contentious issues such as human rights, bribery and the environment. In addition, they may explicitly exclude so-called ‘sin stocks’, such as those involved in tobacco, alcohol, armaments and adult entertainment.
But an integrated ESG approach will go beyond simply excluding certain types of company. Careful analysis of the ESG factors affecting every potential investment can offer clients more than just a clear conscience; it can help to avoid stocks that may cause problems in future, while better preserving capital. A seemingly cheap company with the right product might look very attractive on traditional fundamentals (price/ earnings ratio, expected growth, product mix, etc.), but without sound ESG practices, problems could be lurking. Fines, mismanagement, boycotts and negative PR can all hit earnings later down the line.
Indeed, there is growing research that suggests investment strategies emphasising companies with strong ESG credentials are likely to outperform over the longer term.
This should hardly come as a huge surprise. Social media and a 24-hour news cycle have made it harder for businesses to hide their shortcomings. Companies may profit at the expense of the environment or society in the shorter term, but, over the long term, such behaviour is likely to inflict damaging regulatory and reputational costs.
Perhaps the most high-profile example from recent times is Volkswagen’s false-emissions scandal, which has, so far, cost the company in regulatory fines, car recalls and customer and shareholder compensation, with the total bill currently standing at USD32 billion.²
PROMOTING POSITIVE CHANGE
As stewards of their clients’ capital, responsible investment managers with a long-term perspective have a major role to play by engaging with companies and joining industry debate around policies and practices. Holding companies to account and encouraging best practice should help to foster positive change.
Responsible investors can use their power by exercising their rights as shareholders and vote at company annual general meetings (AGMs). Indeed, voting trends during the 2018 AGM season suggest some investors are becoming more rebellious, choosing to vote against boards instead of with them. Executive pay and remuneration is a widely discussed topic, driven by a perception that many companies are not yet aligning their top teams’ pay packets with company performance. As a result, shareholders have objected to salaries proposed for company bosses at more than 120 FTSE All-Share company AGMs this year.
Finally, investment managers who put responsible investing at the very core of their philosophy may seek to influence debate on a wide range of ESG-related issues via policy outreach work. This involves collaborating with like-minded investors on policy initiatives that could influence practices at a sector or government level.
Policy outreach is important in helping companies address complex and everchanging ESG challenges more effectively. Huge public data breaches and the losses suffered by the companies exposed in recent accounting standards scandals, for example, mean that data security is no longer just an IT issue, but a key ESG risk.
By incorporating ESG factors into an investment philosophy, investors are not only adhering to the increasing need for more responsible approaches to investment, but also accessing more sustainable businesses that will create enduring value over the long term.
¹ For more on ‘next generation’ clients, see November STEP Journal, p.69
² As depicted in the Volkswagen CFO’s latest company report (September 2018)
This article first appeared in the November issue of the STEP Journal.
John Soler is an Investment Director at Sarasin & Partners. If you would like to know more please click the links below.
www.sarasinassetmanagement.com for US clients