ESG and the future of investing

Supported by
Royal London Asset Management
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Supported by
Royal London Asset Management
ESG and the future of investing
Denis Charlet/AFP via Getty Images

One of the biggest concerns about ESG is that it excludes parts of the investment universe, hurting returns.

The good news is that funds which market themselves on their ESG credentials do not just focus on companies fighting global warming, with many of them incorporating technology stocks.

But if you are expecting ESG funds to be investing in small and innovative renewable energy companies, you might want to think again.

According to Morningstar, eight of the 10 best-performing large-cap US funds that incorporated ESG principles had Apple, Amazon or Microsoft as their biggest holding in the year ending July 27.

If you are expecting ESG funds to be investing in small and innovative renewable energy companies, you might want to think again

Separate data from Refinitiv also shows that out of the top 10 performing funds that it labelled ESG in the year to June 30, 19 per cent of assets were in Faang stocks – Facebook, Amazon, Apple, Netflix and Google – or Microsoft.

  • ESG stocks can include tech stocks.
  • ESG stocks have to be sustainable.
  • Greenwashing has become more prevalent.

Technology companies tend not to have a reputation as carbon emitters and therefore seem like a safe bet if your clients’ investment goal is focused on climate.

They have also been some of the best-performing investments over the past decade, in some cases quadrupling returns for investors. So it is easy to understand why so many fund managers are keen to have them in their ESG portfolios.

Exposure to trends

Technology companies are increasingly providing solutions to many of the problems the world faces, such as water scarcity, pollution management and climate change.

Advisers who adopt an ESG strategy incorporating tech stocks can give their clients exposure to the industries and trends of the future.

Technology companies also potentially benefit from having more transparent ESG reporting policies, another contributing factor to their dominance in more mainstream strategies.

Harry Waight, portfolio manager, global equities at BMO Global Asset Management, says an effective ESG strategy needs to embrace companies aligned with the sustainable trends of the future.

He says: “There are many such trends to capitalise on, from sustainable mobility to technological innovation, to good health and wellbeing. One major trend is the epochal energy transition underway, as we move to a materially less carbon-intensive economy.

“This trend towards sustainable fuel sources will be a vital part of the global economy for decades, and a prudent sustainable strategy will seek to align with that.”

However, it is wrong to assume that tech stocks are automatically ESG-friendly.

For example, Facebook has had to deal with the fallout from the Cambridge Analytica scandal and concerns over data privacy, causing some ESG funds to rethink their interest in the company.

Meanwhile, Amazon has been slated for its working practices and Google has been investigated over its monopoly status.

Nicolo Bragazza, investment analyst, portfolio management at Morningstar Investment Management Europe, explains: “It would be too optimistic to think that ESG is the investors’ philosopher’s stone, able to automatically give them the power to find good businesses with the potential to thrive in the future.

“Sectors such as the tech sector and alternative energy are not immune from ESG risks. Specifically, even if not exposed directly to environmental risk, many tech businesses have issues with data privacy and cybersecurity, or they may face scrutiny from governments with regards to anti-competitive behaviour and taxes.”

Metrics

Within the past few years there has been an explosion of different strategies coming to market, allowing investors access through fund-based solutions.

There are varying degrees of exposure across the spectrum of capital, ranging from negative screening and general ESG risk integration, through to sustainable and more specialist impact strategies.

As a result of improving company disclosures, data on ESG investments is increasingly being made available to investors, helping them to identify and understand how sustainable a company is.

However, critics argue that the lack of a widely-used standard for ESG metrics means the door is wide open for greenwashing.

Declan McAndrew, head of investment research at Foster Denovo, says investors should adopt a healthy scepticism and scrutiny over whether funds are doing what they say on the tin.

He adds: “Greenwashing has become more prevalent amid a trend of managers simply rebadging legacy funds with a new sustainable label to attract investor interest.

“Our role as an adviser is to help them navigate this landscape and ensure they are accessing solutions that are both credible and going to contribute to achieving their long-term goals and ambitions – be that financial, moral or ethical.”

Kristina Church, senior investment strategist, sustainability at Lombard Odier Investment Managers, notes: “ESG metrics do not always provide enough data to identify the most sustainable companies over the longer term, and that many technology companies are growing their carbon footprints as demand grows.

“It is vital to move beyond basic, exclusionary ESG metrics to full sustainability integration, with a focus on forward-looking, judgmental analysis of company business models in order to understand which companies are ready for a more sustainable future.”

Future-proofing portfolios

Research by Morningstar suggests that companies which embrace low-carbon technology and treat their employees fairly are more likely to be future-proofed and have consistent cash flows.

Meanwhile, a separate study from HSBC found that ESG issues make up an estimated average of 43 per cent of the key medium-term financial performance drivers.

So could investing in the industries of tomorrow help future-proof clients’ investments?

Ms Church says companies that do not reduce their carbon emissions may find it hard to be profitable in the future.

“Both investors and consumers are assigning increasing value to companies that transition fastest and understand the need to develop new, more sustainable business models,” she says.

“They risk losing market share to those that are able to operate in a carbon-constrained world. Understanding a company’s exposure to future sustainability challenges will help to identify those failing to transition and where investment could be misplaced.”

Ultimately, however, as Mr McAndrew says, while ESG investing can help identify both future winners and losers, there is no “silver bullet” that can future-proof a portfolio in its entirety.

Stephen Little is a freelance journalist​​​​​​​