A November 2018 Monmouth poll found that 78% of Americans now believe climate change is real, up from 70% three years ago. For the first time, a majority of Republicans (64%) accept it vs 49% in 2015. Moving in the right direction but still low percentages. Climate change deniers have long had more traction than they should and this is in part due to the dry way climate scientists communicate (i.e. via boring old boring old scientific journals and balanced debate). The scientific communication machine is simply not set up to counter a co-ordinated misinformation campaigns and social media memes.

I see some similarities in the ESG / sustainable investment debate. To be clear, I’m not saying alpha from sustainability analysis will magically make your fund manager a great stock picker, but it helps. There is a growing body of evidence of this and it is even stronger than many traditionally accepted “alpha factors”. Regular readers may remember my blog of June 2018, which supports this view and jests that 60% of the time it, works every time.

Some ardent ESG deniers will never shift their position, but too many swing voters are still in the wrong camp. The “performance cost” meme is strong and as mentioned in the blog above, researchers have noted that “clients want incontrovertible evidence that sustainability adds alpha before considering it”. This is not the case for any other alpha factors and is convenient for the denier because unlike climate change, incontrovertible evidence can never be found.

Which brings me to our communication problem. Like climate change scientists, I sense timidity (and frankly dullness) in how some of the ESG community communicate.  It’s the same problem. Dry and balanced debate meets cynical and often conflicted incumbents.

Dry / meek statements Positive / conviction alternatives
ESG is really just a risk management tool which reduces the chance investor exposure to controversies and disasters

My experience suggests sustainability analysis is useful for identifying sources of competitive advantage

ESG is less important to some companies than others

All companies are different and their material sustainability issues are different as a result, but that doesn’t mean they are less important. Facebook and Vale are two recent examples of this. We think it is self-evident that identifying those material issues and tracking them over time will add value
Alpha from ESG really just comes from the assessment of governance

Evidence suggests that E & S factors are equally as valuable sources of investment alpha*  Intuitively, environmental and social issues can be very material to many businesses

ESG is very difficult to do in emerging markets

This creates opportunity. Evidence suggest that the emerging markets are actually where ESG is most valuable* More bottom up hard work may be required though

We don’t believe there is value in judging a company on the sustainability of its products. Who are we to decide?

The sustainability of a company’s products is vital to its long-term strategic success. In this respect, strategic positioning and vision can be a long-term tailwind or headwind. An unsustainable product (i.e. coal) is a huge strategic headache for any management team, just as a sustainable one will create a tailwind of opportunities.

The risk adjusted returns of an ESG fund are only slightly better/worse than a traditional fund Many ESG studies show improved risk adjusted returns vs. traditional funds, lower volatility and higher returns. However, risk is a backward looking measure and the cohort of sustainable/ESG funds is historically small. We see no reason why a well-managed sustainable investment portfolio won’t achieve equal risk adjusted returns over the short-term and have the potential to achieve higher risk-adjusted returns over the long-term (it all depends on the quality of the stock picking)

There is a culture and history that goes some way to explaining the lack of ESG conviction. ESG research departments have historically operating like a risk management department. They were advisors who only stepped into an investment decision in extreme (typically bad) circumstances. N.B – With our global sustainable equity strategies, we deliberately counter-positioned ourselves from this approach, which I discussed in ESG Collaboration – A Third way?

Lately however, ESG integration has become a core requirement in everyone’s investment process and credible sustainable and ethical investment strategies are seeing strong demand. The average ESG Researcher or manager now has a vital communication role.  Whilst I’m always wary of hype and marketing in our industry (and the number of sustainable funds launched in the last year may be an indicator of such), I believe that we should now be bolder and more confident in the sustainable investment message we are sending. Hopefully my quick reference guide will help you do that.

* Friede, Busch, Bassen (ESG & Corporate Financial Performance: Mapping the global landscape). September 2016

 

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for co-managing global equities portfolios. He joined us in 2014 from SWIP, where he was investment director in global equities. In addition Craig also had analysis responsibilities for the tech, energy and utility sectors. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors, a member of the global environmental equity team. Craig has a 1st Class honours degree in Building Surveying, an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 17 years’ industry experience*. *As at 30 November 2018.

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