InvestmentsOct 28 2020

ESG for income and growth

Supported by
Rathbones
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Supported by
Rathbones
ESG for income and growth
Reuters/Ahmed Jadallah

Throughout history, as asset classes emerge, they evolve as providers refine and expand their offerings. 

An example of this would be, UK equity funds evolving into UK equity income, or UK small cap equity, and then further into something else as different investment styles take hold, with some managers deploying the value style of investing and others the growth style.

The strong performance of ESG portfolios since the Covid pandemic first struck in March 2020 has helped the asset class to evolve, while the regulatory changes mentioned in the third feature of this guide may mean that a new wave of clients will enter the market, leading to the creation of new ESG products.

Nicolo Bragazza, investment analyst in the portfolio management team at Morningstar, says: “Unless ESG investing is interpreted in the narrowest sense of 'impact investing', where impact is more important than profit maximisation, the application of ESG integration should not change the way in which we look at markets through the lens of value/growth or income.

"Globally, the number of companies meeting strict ESG criteria is broad enough to ensure that typical investment consideration could and should be applied. Moreover, this universe is constantly evolving because more companies have started to pay more attention to ESG issues and fund houses are offering new products to expand the ability of investors to build their preferred asset allocations."

Sophie Lawrence, senior ethical, social and impact researcher at Rathbone Greenbank investment, says generally, ESG portfolios are more likely to have a growth bias than a value bias. 

"Technologies, products and solutions to solve environmental problems see accelerating demand supported by policy initiatives and regulation," she adds. 

"This brings growth and increasingly, predictability too, improves momentum scores. Good governance and social scores tend to suggest a risk averse management style, also indicating quality. Not all ESG portfolios exclude fossil fuels and industrial minerals but many do. And it is common to find a lower exposure to basic materials or industries that are economy sensitive and more cyclical, a feature of a value approach.” 

Mr Bragazza adds: “After these considerations, it is extremely important to point out that traditional investment rules apply to ESG investing as well. Value investing: the strategy of buying companies at a price meaningfully lower than their fair value, could be a good way to achieve superior risk adjusted returns and ESG considerations could also be of invaluable help in identifying great companies whose management and practises justify higher value not yet recognised by the market.

Technologies, products and solutions to solve environmental problems see accelerating demand supported by policy initiatives and regulation.--Sophie Lawrence

"As for income strategies, currently there is not a large number of ESG Income funds available to investors, but this is more due to the recent ascent of ESG than with structural limitations of these strategies in accessing companies able to provide sustainable sources of income.”

Growth spurt 

Patrick Thomas, who runs the ESG investing service at Canaccord Genuity Wealth Management, says the next stage in the evolution of ESG portfolios may be around risk levels. 

Francois De Bruin runs an ESG mandate at Aviva investors. He says getting income from ESG investments is possible, but only on a multi-asset basis

He says: “If you invest globally, and have bonds, equities and real assets then income is possible.”

Malcolm McPartlin, co-manager of the Aegon Global Sustainable Equity fund says there are more ESG compliant dividend paying companies now than has ever been the case in the past.   

He says: “We believe the universe is sufficiently diverse at this time, with yield available from a range of ESG friendly companies. Importantly, this yield should be largely uncorrelated to the yield and performance expected from traditional income sectors, which lack ESG credentials.” 

He says he does not yet feel that the asset class has reached the stage in its evolution where investors can choose between portfolios which deploy a particular investment style. adding that there are hardly any value investing opportunities in the ESG universe right now. 

New money 

This would typically be the case when an asset class becomes popular with investors. With the wall of new money, this means assets generally rise in price, leaving little opportunity for value funds which specialise in buying assets that are trading cheaply.    

Mr McPartlin added that many of the areas of the market that are particularly popular with value investors right now, are companies which would not make it into an ESG portfolio. 

If you invest globally, and have bonds, equities and real assets then income is possible.--Francois De Bruin

Many of the companies which are widely held in ESG portfolios have the use of new technology at their core, and should be growing at a faster pace than the wider economy, while perhaps not generating much cash right now, and the cash that is generated goes straight back into the business to fund further growth.    

Noelle Cazalis, who jointly runs the ethical bond fund at Rathbones with Bryn Jones says that there are many fixed income products on the market which offer exposure that cannot be got via equities, in assets which have no correlation to the wider economy, and an attractive income yield.

She says: “The ESG universe allows fixed income investors to diversify away from the traditional sectors and to therefore improve overall portfolio diversification. For example, the charity bond market: charities tend to be uncorrelated to most traditional economic sectors. Some project-specific green bonds can also provide uncorrelated yield.

"Fixed income ESG can also allow investors some certainty over their income – in times where dividends are under pressure. Fixed bond coupons prove attractive to those with specific income requirements.”