Recently, I attended the Cape Town leg of the Schroders Investment Symposium, at which Jessica Ground, the global head of stewardship at Schroders, made a strong economic case for ESG investing.
Ground said there is growing pressure on asset owners globally to show they are being good stewards and that they are holding companies to account, not only in their accounting and governance practices, but also in their social relationships, including those with their employees, and in the impact of their operations on the environment.
She said ESG and sustainability issues are creating real headwinds for business, which companies need to navigate, and there will be a real gap between companies that manage these headwinds and those that don’t, and this will provide opportunities for active fund managers to generate alpha, or returns above what a passively managed index-tracking investment would achieve.
And while the move to ESG is strongest in younger generations, older investors are also showing an interest, as shown by surveys carried out by Schroders over the past three years here and overseas.
What are the headwinds for business?
Regulation is a major driver of change. “After the financial crisis we have seen a rise of stewardship codes. We have seen policymakers and regulators asking the investment chain to become more responsible for the companies they invest in, and South Africa has not been immune to that,” Ground said.
There has also been a raft of regulation worldwide on mitigating the effects of climate change.
The changing climate is also having a direct effect on companies’ bottom lines. “Just looking at losses from natural disasters, they’re growing at 4% compound every single year and rising with increasing frequency,” Ground said.
Changing demographics in the workforce is also a factor, with younger people choosing careers that suit their world view. Coal-mining companies, for example, are battling to attract talent - “who wants to be in the coal industry when coal will eventually be phased out?”
So this focus on ESG and sustainability isn’t just “green-washing for millennials”, Ground said. “It is more about fully understanding the issues that companies are facing, and sorting out the winners and the losers.”
The approach at Schroders is to fully integrate ESG analysis into its investment processes. There’s a strong emphasis on long-term financial benefits - on identifying companies that are best placed to navigate financial storms and headwinds. “We are actively stepping away from more controversial, opportunistic investments and sectors and companies that, in the long term, don’t have sustainable business models.”
Ground said there is a lot of confusion globally about how sustainable investing is defined, so it was encouraging to see that, in a recent survey of South African investors, the vast majority (62%) felt it was about investing in companies that were proactive in being well prepared for environmental and social change, 41% said it involved investments that were “best-in-class” on ESG criteria, 19% felt it was about negatively screening out controversial companies, and 6% didn’t know, which was “actually much lower than the global average”.
She said Schroders tries to keep screening (whereby companies or sectors are excluded for negative reasons) to a minimum, as this reduces diversification.
Ground said many of the myths around sustainable investing delivering poor performance have resulted from the analysis of funds that use screening. These funds exclude so much of the investment universe that the analysis depends on the period under scrutiny, when certain sectors may outperform others.
“But we are starting to see more compelling evidence that integrating ESG into fundamental investment processes can really deliver alpha,” Ground said.
A study out of Oxford done in 2014 - a meta-study of 200 underlying studies - showed that companies with environmental issues pay more to raise capital; companies that demonstrate good governance and social responsibility have a reduced cost of equity; in 88% of studies, there was a correlation between sustainability and operational performance; and companies that have good ESG policies tend to be looked on more favourably by the ratings agencies.
In the column two weeks ago, I bemoaned the fact that there wasn’t much in the way of ESG-focused investment products out there for the retail investor. But perhaps you should be looking beyond the products, to the asset manager itself, to ascertain whether its investment process is guided at a more fundamental level by ESG values.