ESG: Time to align value with values?

The former has been on a good run for the best part of a decade, as they tend to prove highly attractive in subdued economic conditions.

This means that growth stocks have been well-suited to navigate the low inflation and low interest rates environment which has occurred since the financial crisis in 2008.

Value stocks, on the other hand, have fared less well.

David Keir, manager of the TB Saracen Global Income and Growth Fund, recently remarked that despite proving a sound strategy over the long term, but for the past ten years or so value has performed near historic lows.

Value stocks bounce back

But in September value stocks bounced back.

Mr Keir put this down to each new phase of the European Central Bank’s quantitative easing programme yielding few positive results. He said this could be “the first sign the tide is turning.”

“Mario Draghi’s comments on September 12 appeared at last to accept the limits of monetary policy and raised the prospects of fiscal stimulus. As a result, long bond yields may not go much lower and it was notable after these remarks more cyclical companies and financials started to out-perform from very low base valuations.

“We suspect there might be a gradual realisation that, similar to the tech boom of the early 2000’s, sections of the equity market - quality and growth - are trading on peak earnings multiples that are unlikely to be supported by revenue and profit growth.”

Markets can only ignore earnings for so long, according to Mr Keir, who also explains that the divergence in performance between value, on the one hand, and growth and quality on the other, is currently at extreme levels.

Key points

• Growth stocks have suited the recent environment
• ESG factors are now a bigger concern
• ESG is more than about negative screening

“At last, we have seen some pressure on price/earnings ratio multiples on poor results from quality and growth companies and much more caution on initial public offerings after the cancellation of WeWork and the lacklustre performance of Peloton, post flotation.

“It is too early to say for sure, but the future may be looking considerably brighter for value based strategies.”

But in truth, for intermediaries and their clients, few are likely to be concerned about whether a manager is selecting stocks based on whether they are a growth or value prospect.

A bigger consideration, and one that continues to gain serious traction, is a company’s ethics. Increasing consumer demand for environmental, social and governance approaches is being satisfied by an ever-growing number of products to match.

As the Investment Association recently noted, sustainable funds took up a quarter of the total money invested in funds last year.

In addition to this, research from global asset manager, American Century Investments, found that 56 per cent of US survey participants and 59 per cent of UK respondents said the concept of ESG or sustainable investing is either “somewhat" or "very appealing."

For US respondents, this was up from 49 per cent in 2018 and 38 percent in 2016.

And popularity is only likely to increase over the coming years.

As Darius McDermott, managing director at Chelsea Financial Services, notes: “Our research team meets about five fund managers every week.

"A couple of years ago, only a handful of these managers would mention ESG, and they would be the managers who have had it at the core of their process for decades.

Today, however, nearly every single manager we meet makes reference to it.

So you have to be careful that funds are genuinely using ESG – not just saying it as it is fashionable to do so.”

These developments also prompt the following question: If the economic environment was to change over the coming years, and September proves to be a springboard for value stocks, would it also be advantageous for ESG funds to adopt such a strategy?

Daniel Pereira, investment research analyst at Square Mile Investment Consulting and Research, is hesitant to draw firm conclusions on the matter, saying that every manager’s approach is different and consequently will have a varying return profile.

He says: “Although growth stocks have led market returns in recent years, it is worth remembering that those currently trading on excessively high multiples can be very quick to de-rate on changes in market sentiment, such as what was experienced over the fourth quarter of 2018.

Will growth stocks continue their run?

If a growth company meets a certain ESG criteria, it does not insulate the share price from such market volatility.”

There is also the broader argument of whether growth stocks will continue their good run of form.

On this subject, Mr Pereira says that as growth stocks continue to soar, the days of value outperforming are seemingly becoming an ever more distant memory.

“Growth stocks have performed well in an environment of low economic growth, which may have been further exacerbated by a rise in algorithmic trading which buys index positions, regardless of price or valuations," he says, adding: “However, we have also seen some brief spells of value outperforming such as in 2016, around the time of President Trump’s election, and during September of this year.

"Such catalysts for value to enjoy a sustained rally, and growth to therefore lag, are difficult to predict, even for the most highly regarded economists and market commentators.”

In conclusion, he says that value is likely to outperform at some given point, but concedes that predicting when this is likely to happens is difficult to pinpoint.

However, a shift from growth to value could have its complications.

As FTAdviser's now closed sister-title, Investment Adviser, noted in December 2016, part of ESG's outperformance "is down to these funds’ bias towards ‘quality’ stocks, a section of the market that has flourished since the financial crisis as nervous investors sought out reliable companies."

More recently, FTAdviser title, Asset Allocator, flagged a further concern.

It said: "The world of ESG is now about much more than just negative screening. Yet the past year has seen certain ethical investment strategies opt to exclude some of the biggest growth stocks of the past decade. Increasingly, this is a complicating factor for those wealth managers who run their own specialist portfolios or buy ethical funds."

In any case, Aled Phillips, chartered financial planner and operations director at Niche, a firm which has recently set up Niche Ethical specifically for ESG and charity investment, says that regardless of whether growth or value is more attractive, the performance outlook for ESG funds is encouraging.

He says: “When you look at the evidence, it indicates that companies that show the characteristics which an ESG investor is looking for tend to be better companies, so this could actually mean that they would produce a better return during times when market growth is lower.

“These companies can demonstrate that they care about their employees, environment and the sustainability of their business model.”

Craig Rickman is a former special projects editor of Financial Adviser an FTAdviser