Guest blogger Adam Rawling from Tatton Investment Management highlights how investors and businesses alike will find it more difficult to ignore ESG investing, especially as it becomes less niche.
This year the UK is playing host to the UN’s Climate Change Conference, and with the US re-entering the 2015 Paris Agreement, climate change has once again been thrust into the limelight.
The appetite for responsible investing is also growing, despite the wider pressures presented by the global pandemic and numerous political events that shook the world over the past 12 months. In April 2020, during the peak of the COVID-19 lockdown, investments into responsible investment funds reached a record £1bn. The first half of the year saw four times as much being plunged into this area of the market than in the same period a year earlier.
A wave of new ethical fund launches last year also broadened out the options for investors, with close to 3,000 ESG or ethical funds now available to investors.
Fuelling the surge in demand for more ‘climate aware’ approaches are the millennials with a recent survey from KPMG suggesting that 81% of this group are demanding to know more about responsible investing.
Most company executives, too, are beginning and understand and improve the role they play in ensuring that the ESG policies of their businesses are in line with the values of their customers.
In fact, the ESG and responsible investing landscape is changing so much and so fast that it is likely we will soon reach a point where it simply becomes the norm and funds, by default, will be ethical in nature from the get-go.
While this mainstreaming is largely welcomed by the industry and investors, it does present some challenges, such as the definitions of what is ‘ethical’ and whether investing responsibly ultimately detracts from performance.
Ethical, societal or environmental?
Let’s take the issues surrounding ‘what is ethical’ first as this is really very open to interpretation as one person’s ethics won’t necessarily be the same as another.
As is currently stands, there is no industry standard or set in stone rulebook as to how asset managers or investors should apply ethical criteria. Much is based on an individual’s, or group’s, understanding of what is ‘good’ versus ‘bad’.
That’s not to say that one is better than the other, it is simply a question of what the investor is comfortable with in terms of that product’s approach and concerns.
In the early days, for example, a common approach taken by fund managers was to work from an exclusion list - not investing in any companies related to arms or nuclear weapons. Over recent years, however, a broader approach has evolved which looks more at responsible businesses, diversity in the workplace and long-term sustainability.
Tatton Investment Management’s own research into what is driving advised clients towards responsible investing showed armaments, animal testing for cosmetic purposes, the fur trade and pornography were of the highest concern - a quarter of those that took part said this was a red line and would point blank refuse to invest in these industries.
The overarching message here, however, is that the societal impact of investing carries a greater importance when making portfolio allocations, above the more general environmental concerns such as oil and gas, nuclear energy and tobacco, for example.
Benefit or blow to performance
The entrenched belief that by ‘investing for good’ you are forfeiting the potential for amazing returns on your investment is, simply put, a myth. Stock markets suffer highs and lows whether you are investing ethically or not.
What is true is that by taking an ethical or responsible approach you will be ruling out some areas of the market based on how strict those ethical principles are. A strict UK ethical fund, for example, could see more than 60% of stocks disappear from their investment universe, while those that have a less severe approach may only have to avoid 5% of the stock available.
KPMG data shows that over the last five years, more than half of UK investors up their allocations to ethical funds - which suggests that the argument that returns are sacrificed when taking an ethical approach has already significantly diminished.
To add further weight to this, out of Morningstar’s 56 ESG indices, created to analyse ethical investment performance, 41 of them have outperformed their non-ESG cousins.
This isn’t a fluke, or one-hit-wonder. Back in 2018, Morningstar figures showed the performance of 63% of sustainable funds saw them positioned in the top half of their respective categories.
It’s not just the end investor that has benefited from being more ethically minded or socially responsible in their approach.
Companies that have engaged with ESG principles and altered their business models have seen a positive impact on their corporate financial performance. In 2019, and MSCI study found a direct correlation between improved profits and higher dividends being paid to shareholders at companies that had high ESG ratings.
With evidence like this, investors and businesses alike will find it more difficult to ignore ESG investing, especially as it becomes less niche.
There may well be just 2,739 ESG or ethical funds compared to a near 18,000 ‘regular funds’ to choose from at the moment, but the next decade in which companies will increasingly align themselves with the Paris Accord and offshore wind will become a primary fuel for UK households, those that ignore this segment of the market risk missing a great investment opportunity.