Back to the future: a decade of sustainable investing

The classic device for taking readers back in time is to reference Apple products. In this case, when we launched the funds in 2009, the original iPad wouldn’t arrive for another six months, while consumers were moaning about the battery life of the new iPhone 3GS. Talking to our computers, like we now do with Siri, seemed a world away.

In other circles, global stock markets were more-or-less at their post-global financial crisis lows; Gordon Brown was still Prime Minister, with the fresh-faced David Cameron and Nick Clegg a year from taking office; the Nissan Leaf electric car was a year from launch in Japan and the US; and, while the UK government had just doubled the subsidy to install solar panels on your roof, this remained a very avant garde way to reduce your energy costs. The world has certainly changed.

Sustainable goes mainstream

The biggest change for me within investing has been a silent revolution: the acceptance of sustainable investing, alongside other well-known styles such as value, growth and income. This reflects two developments. First, there is now strong evidence that integrating sustainability into investment decisions enhances returns. Why should an environmentally-poor, socially-irresponsible, badly-governed company be a good investment? It won’t be.

Secondly, more consumers are considering not just what a product does, but the environmental and social context in which it has been produced. These considerations will increasingly be a factor in their investment choices, where consumers will rightly be concerned about how their money is being invested.

Some commentators attribute this increased awareness to the emergence of millennials. There is some truth in this: this generation now outnumbers baby boomers as adult consumers for the first time. This argument is, however, a little simplistic. In my experience, older people can be just as passionate about sustainable investing, not least as they consider their legacy to their children. Instead, I believe there is an ongoing societal shift towards understanding the importance of environmental, social and governance (ESG) factors, which form the bedrock of sustainable investing.

It started with G

The emergence of these factors as mainstream investment considerations is rooted, as many things are in financial services, in the avoidance of bad. The global financial crisis highlighted how woefully bad corporate governance was. Investors barely enacted their rights as shareholders, leading to an amoral void of poor limited financial disclosure and bad corporate practices.

I started work as an accountant in the aftermath of Maxwell and Polly Peck, which led to significant improvements in disclosure, accounting standards and equity research. Yet by 2009, it became clear how little active engagement shareholders had with the companies they owned. Such destruction of capital couldn’t be allowed to happen again, so corporate governance (G) has slowly become more mainstream.

Within this dynamic, there has also been a shift from negative to positive governance effects. As an example, considering the optimal composition of corporate boards from a gender and ethnicity perspective shows that companies and investors are starting to realise the positive gains that effective governance can bring. There’s a lot further to go, in my opinion, as some big tech companies demonstrate. However, you can’t overstate the importance of good corporate governance – it’s like gravity, always reasserting itself in the end.

Over the last two or three years, there has also been a sharp increase in awareness of environmental and social factors, and their influence on investment returns. Whether in plastics, carbon footprints, data or long-term social effects, there is a clear alignment of the big issues of the day with sustainable themes.

So, sustainable investing has moved into the mainstream and for very good reasons. 

Increased interest in fixed interest

Another significant change has been the move to considering both equity and debt from a sustainable perspective. Equities were the natural starting point for sustainable investing, given the extra benefit of shareholder rights and influence, which debt investors do not get. Also, there was a historical lack of debt issuers with an explicit social or environmental benefit. This has changed noticeably. Green bonds have made the headlines, but even away from these there has been a sizeable increase in debt issuance from sustainable entities. Interestingly, there is a large market inefficiency to exploit here.

As Martin Foden, our Head of Credit Research, says: “Much of the ESG data and analysis used today is still centred in equities. Some investment firms use these tools and read across from equities to credit. Their claims about multi-asset sustainable investing appear reasonable at a high level, yet they quickly unwind for two reasons. First, only around 40% of the bonds in the sterling credit index have a public equity profile. Not only does a focus on companies with a public equity listing greatly reduce the opportunity set, it is also the very area of the market which is already most efficient.

“Secondly, while there are clearly similarities, equities are fundamentally different from credit. What works for one isn’t always relevant or important for the other. Crucially, the risk/return payoffs are completely different. Unlike equities, credit risks are asymmetric: upside returns are capped, however the company performs, yet deterioration can lead to negative returns, through default, forced sale because of fund restrictions or mark-to-market losses. The relevance of ESG factors is obvious: risk doesn’t discriminate and its origin doesn’t matter.

“Given the skewed nature of returns there is, arguably, no asset class to which sustainability is more important than credit. We believe it is hard to outsource effectively the analysis of ESG risks to third parties. The only credible solution is proper, bottom-up research and an investment process that acknowledges the false distinction between traditional credit and ESG analysis.”

What hasn’t changed?

One thing that hasn’t changed over the last 10 years is that sustainable investing must demonstrate its ability to deliver above market returns to be successful. You can be as sustainable as you want, but if you’re not also delivering good investment terms, you won’t be serving your clients’ interests. 

As an example, I generally don’t invest in initial public offerings (IPOs). This may be surprising given the transformative power of technology in a sustainable world, and the need to support those companies with vision at an early stage. This, however, is the point: it is so easy to get sucked into fantastic technology stories well before a business is properly developed, let alone a robust investment case based on actual financial performance. 

A look at this year’s tech-related IPOs shows how hard it can be to make money in hyped-up new issues: Uber, Lyft, Peloton… I say tech-related as many businesses are packaged as tech IPOs, when they’re far more prosaic in reality. An excellent current example is WeWork, which has struggled to make it to market: while it has some tech entrepreneur clients, it is in practice flexible office space, not unlike Regus. Even without this, the stock would have failed our governance criteria.

Looking back is important. However, the purpose isn’t to ruminate on the past, but to seek clues about the future. In my next article, I will look at the possible themes for the next decade of sustainable investing. I doubt it will mention hoverboards, but there will no doubt be big changes on the way to 2029.

_{Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.}

_{For more information on the fund or the risks of investing, please refer to the fund factsheet, Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.co.uk}

The views expressed are the author’s own and do not constitute investment advice. All information is correct at October 2019 unless otherwise stated. Issued by Royal London Asset Management Limited, Firm Registration Number: 141665, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, Firm Registration Number: 144037, registered in England and Wales number 2372439; RLUM Limited, Firm Registration Number: 144032, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between sub-funds, authorised and _{regulated by the Central Bank of Ireland, registered in Ireland number 364259.}

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