Friday HighlightApr 24 2020

Time to start pointing clients to ESG funds?

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Time to start pointing clients to ESG funds?

The Covid-19 lockdown-related reduction in oil demand, combined with a price war between two of the biggest suppliers, Saudi Arabia and Russia, has wrecked the fossil fuel market.

Despite recent promises by President Donald Trump to help restore relations between the two oil giants, the price of crude oil has been falling - even into negative territory - and taking down along with it those companies and sectors associated with the fossil fuel industry.

Conventional funds with exposure to fossil fuels have taken a huge hit as shareprices plummeted, while those invested in companies with strong ESG strategies have been protected from the blow.

It is easy to say this is because many 'green' funds employ screening against environmentally damaging and volatile commodities, like oil.

However, funds that hold themselves out to be aligned with ESG principles also have been investing in those companies with solid growth potential as the trend towards clean energy and carbon-neutral business models grows irrespective of global pandemics or fossil fuel woes.

This has presented a double benefit: avoiding sectors most exposed to macroeconomic shocks and investing in companies that have a strong pipeline of business ahead of them.

Indeed, recent reports state MSCI Europe ESG Leaders index has been outperforming the EU benchmark by 180 basis points since the beginning of the year - long before Covid-19 came onto the scene.

We do believe that oil is a structurally challenged business.--Simon Clements

MSCI’s Japan and US ESG Leaders indices have outperformed by 50bp.

ESG funds are also reported to have only fallen half as much as the S&P 500 Index during the coronavirus pandemic. 

Value in ESG

Simon Clements is manager of Liontrust Sustainable Futures Global Growth Fund. He points to the fact that when times are tough and markets show volatility, ESG funds exhibit greater stability.

Mr Clements says: “We do believe that oil is a structurally challenged business. The transportation sector is still heavily reliant on oil, and with the inflection we are seeing in electric vehicles, and increasing awareness of the risks around climate change, we view it as ex-growth and risky.”

“Over the past three years, we benefited from having a zero weight to the entire energy sector because our process is fossil fuel free. Around 10 per cent of the three year outperformance versus the MSCI World benchmark is attributed to our energy position.” 

Mr Clements cites the stocks of two companies - Cellnex, a European Tower company, and Thermofisher Scientific, a US based Life Science company - as contributing about 4 per cent of the entire portfolio between them over the past three years.

Being more exposed to companies with high return profiles and strong ESG strategies in place, such as within the healthcare and technology sectors, equates to greater resilience.--Masja Zandbergen

“This demonstrates how important just those two stocks are, compared to our energy underweight,” he says.  He believes that companies which are part of “the transition to a more sustainable global economy” like Cellnex and Thermofisher “are what drives performance”. 

Like Mr Clements, Masja Zandbergen who heads up sustainability integration at investment firm Robeco, feels that an advantage of ESG funds is their resilience. 

Ms Zandbergen says: “We see that being more exposed to companies with high return profiles and strong ESG strategies in place, such as within the healthcare and technology sectors, equates to greater resilience. The strategy avoids large investments in the more risky, cyclical sectors such as energy and financials, and this provides downside protection.”

Robeco places a lot of weight on companies with strong human capital management. This is another ESG related theme that Ms Zandbergen values highly in terms of sustainability, particularly during times of crisis. 

“Human capital development not only ensures that the company has the appropriate skill set to execute the business strategy," she says. 

"But it also improves talent attraction and retention, and employee motivation; and, as a result, productivity and the potential for innovation. Companies with good human capital management have invested in their employees and will be well served by having retained a well-trained and committed workforce when business operations are able to resume, we believe.”

Taskforce aims

The growing demand for companies to develop strong ESG strategies has been illustrated by the creation of the Financial Stability Board’s Task Force for Climate-related Financial Disclosures. The Task Force puts measures in place to ensure companies demonstrate sound ESG reporting rather than ‘greenwashing’. 

This is evidence that climate change accountability is being increasingly interpreted as a sign of financial stability.

In fact, it has led the Investment Association, whose members own one-third of the value of listed companies, to ask companies to explain in their annual report the impact climate change will have on their business model and how these risks are being measured and managed. 

Andrew Ninian is director for stewardship and corporate governance at the IA, says: “Climate change could result in a significant loss of value in companies if risks are not effectively measured and managed, ultimately hitting savers’ pockets.

"Companies need to be looking at the impact of climate change on their business, products and strategy and set out to investors how they are responding to these risks.”

We may not like the idea of a mining company, but far better to invest in one that has strong environmental credentials and helps build social projects in the countries it operates in such as schools and hospitals, than one that doesn’t.--Tim Cockerill

This is a key example of how ESG strategies including climate change risk mitigation, are now more than ever being looked on as an essential aspect of assessing the viability of a business. It is clearly a growing area and one to watch, but there remain complexities around choice. 

These complexities are explored by Tim Cockerill, investment director of wealth management firm Rowan Dartington.

“Whereas exclusion of business such as tobacco, armaments and gambling are still important, funds need to have an investment policy that positively identifies businesses helping to build sustainable futures.

"These can be found in a wide range of sectors, from building to agriculture. This is why investors have to do a little digging into how funds select their stocks”, says Mr Cockerill. 

Pragmatism needed

He thinks that investors also need to be pragmatic because business is complex and so are the challenges people face. “Should you invest in a mining company? Mining does damage to the environment, yet if motorists are to switch to electric vehicles, raw materials are needed to build them.”

But this also is where pragmatism does a U-turn back towards ethics. Mr Cockerill adds: “Investment groups who are serious about sustainability get involved in engaging with companies they own and bring pressure on them to improve what they do.

"We may not like the idea of a mining company, but far better to invest in one that has strong environmental credentials and helps build social projects in the countries it operates in such as schools and hospitals, than one that doesn’t.”

Making such choices is about ethics as much as sustainability.  These are two very positive pillars holding up ESG investing rationale. ESG investing helps transform the world, and at the same time it creates better all-round sustainability. 

Ms Zandbergan says: “It is true to say that ESG funds have outperformed in volatile markets, including the crisis of 2008-2009, and turbulent periods in 2015 and late-2018.” 

She concludes: “There are powerful drivers to sustainable investing that suggest that it is here to stay. Societal awareness of environmental issues [together with] regulatory efforts to drive capital towards green investments are set to continue.”

Anita Boniface is a freelance journalist