ESG – Just Another Sales Gimmick?

The Financial Services Industry is addicted to acronyms, in part one wonders if this is to maintain the illusion of the man behind the curtain, with one of the more recent buzzwords, “ESG”, which stands for Environmental, Social and Governance. So, what is it and what does it mean for investors? ESG is broadly defined as covering investments that provide a positive return through well managed companies with a focus upon sustainability. In practice this is represented by companies that are aware of their impact not only upon the environment, but also on the welfare of their employees and act responsibly (no bribing for example).

ESG is not the same as Ethical investing where there is an inherent bias to do good and as a result the universe of ESG companies is far larger.  The UK market is heavily exposed toward energy companies and an ethical fund’s screening in this sector could automatically reject these companies due to environmental damage or the dangerous working conditions and practices for their employees. However, with an ESG fund, investments can be selected on a best in class approach i.e. which investment does the least the damage.

The development of an ESG strategy recognises that many of today’s investors do want to consider the societal impact of any investment versus their need to generate investment returns.  Whilst ethical funds offer a similar objective, their restrictions and social objectives often mean that the acceptable investment universe is very small and finding mispriced or high growth investments very challenging. Consequently, there can be an unacceptably high-cost in performance terms. 

The ESG investor has a wider investment choice and therefore should be less exposed to performance consequences because they focus upon companies that are well managed/governed with long-term sustainable business practices, attributes that should prove attractive to most investors. This gives the ESG investor a much better chance of identifying under-priced securities or high growth companies as only a few ESG funds invest purely on the ESG factors alone.  

So where do we sit on these issues? As real return investors we are not shackled to chasing an index and therefore how we use our investment freedom is a key question.  This is a very subjective area and one where we need to decide on what is acceptable on behalf of our clients. At one end of the spectrum, as human beings, we would want to see an end to global poverty, but it is hard to see how this could be achieved and whilst we are not ethical investors (specific mandates aside) we do believe we have a moral obligation in how we invest our clients’ funds

There are many occasions when we reject a fund on investment grounds but occasionally we cannot invest for other reasons.  A recent visit from a Russian based manager of a Russian Equity fund stunned us, as when asked how ESG affected his approach he replied, “I reckon there is about 3% of my portfolio related to slave labour, but no more”. To us this was reprehensible and a completely unacceptable investment.

The larger asset managers have for some time been offering ESG mandates to the institutional world where pension fund trustees have, for example, demanded a more socially aware framework on behalf of their members. These groups have the infrastructure to provide the necessary ESG due diligence and are now offering these funds to the retail market. Our sense is that over the next decade most retail fund offerings will start providing information on their approach to ESG as a matter of course.

Our focus, on behalf of our investors, is to consider the widest possible investment universe on behalf of our clients and apply our common sense, pragmatism and ability to create attractive returns.

James Calder
Research Director


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