Key takeaways: ESG – discover the future of investing

Environmental, social and governance (ESG) has been on the rise for years now, with more and more companies shifting to a greener approach.

But how do we incorporate ESG factors into our portfolios, and how does this affect both risk and returns?

Key takeaways: ESG – discover the future of investing

ESG (environmental, social and governance) is a hot topic in the world of investing right now.

But how important is it, and does adding an ESG screen to a portfolio detract from returns as some people think? Or can it actually reduce risk and help us identify great potential investments?

How do we check that companies are actually “walking the walk” and doing what they say they’re doing rather than just “greenwashing”?
And is it possible that we can actually use our capital as a force for good and make a positive impact on the world, rather than avoiding the bad companies?

I recently caught up with Ashley Hamilton-Claxton at Royal London Asset Management to ask her how they deal with such issues. You can view a recording of our conversation by clicking here.

A good company vs a good investment?

It was very clear from our discussion that there is no real difference between being a “good company” and being a “good investment.” By and large, if a company has a positive set of values and a clear purpose, they are more likely to be a good investment as well as a positive influence.

On the flip side, companies with poor governance rarely make good investments!

Engaging

Ashley was equally clear that engagement is generally a more effective tool than divestment. She used the example of Glencore, who are one of the world’s largest mining companies and a big polluter. However, they are one of the biggest producers of copper which is very important for electronics, and we need technology to help in the fight against climate change.

Rather than looking to pull their money away, Royal London (and others) instead engaged with the company about ways they can reduce their impact. Partly as a result of this engagement, Glencore is now committed to becoming carbon neural by 2050.

Shades of green

Whilst there are plenty of data tools to help analyse a company, much of this is subjective and there are many grey areas. It therefore requires a human “qualitative” review as well. For example, the issues with BooHoo, where many of their suppliers were poorly treating their staff, did not show up in the data. As a result, a number of so-called sustainable funds owned the shares.

However, Ashley felt that it wasn’t difficult to detect these issues simply by using a common-sense filter and a bit of Google! There had been concerns raised before and, in some cases, it simply wasn’t possible for suppliers to produce the goods so cheaply without compromising on standard in some way or other.

We also discussed other examples, such as Tesla which is held in lots of sustainable funds due to the positive impact its technology could have on the fight against climate change. However, Tesla fails on Royal London’s governance screen and so wouldn’t be in their sustainable portfolios. Their recent purchase of Bitcoin has also hurt their environmental credentials given the amount of electricity Bitcoin mining uses!
We also discussed funds which badge themselves as “impact” funds. Ashley thinks the term is over-used and whilst many of the funds might be “sustainable”, they are not really having a positive impact on the world.

For example, buying shares in large, listed companies on the secondary market can’t have that much of a positive impact, no matter how positive their product might be. By contrast, providing financing to a small company who are struggling to get their innovative product off the ground can have a huge effect. This, of course, is a much riskier investment, although the financial rewards can be huge if the investment pays off.

Equilibrium’s approach

In Equilibrium’s portfolios, we monitor holdings for various ESG metrics and engage with the fund managers we invest with. We don’t generally hold the companies directly and so we rely on fund managers to act on our behalf.

Equilibrium are signatories to the United Nations Principles for Responsible Investment (PRI), which means we commit to including ESG in our portfolio decisions. We insist that any fund manager we invest with must also have signed up to the PRI.

Our core portfolios are well diversified across multiple different asset classes, fund managers, and thousands of underlying companies. This diversification helps to mitigate volatility, but it does mean it is difficult to make a positive impact with our clients’ money.

We are therefore in process of developing a more concentrated “Positive Impact Portfolio” to sit alongside the core funds. This will be riskier than the core fund but should be able to have more of a positive impact. We will measure this by comparing holdings against the UN’s Sustainable Development Goals and only investing in companies who are making a positive difference towards those goals.

This portfolio will be higher up the risk spectrum; but also have higher return potential. It will also be further up the impact scale, although not to the level of providing funding to early-stage companies. We are able to help clients in this area by looking at tax efficient investments such as Enterprise Investment Schemes (EISs), although these are even riskier.

The biggest impact we can potentially have might be through giving, rather than investing. We are also able to help clients channel their philanthropy and help them leave a positive legacy for future generations.

The content contained in this blog represents the opinions of Equilibrium and is based upon our current understanding of rules and regulations. The commentary in this blog in no way constitutes a solicitation of investment or financial advice. It should not be relied upon in making investment or financial decisions and is intended solely for the entertainment of the reader.