Fans of the film Anchorman will instantly recognise Brian Fantana’s outlandish claim about his aftershave that “60% of the time, it works every time”. In the real world, any investor will tell you that these are very good odds. Over the last year, the empirical evidence has continued to build that Sustainability analysis (or ESG) can generate alpha. Sustainability is a useful instrument in the investor tool kit and >80% of senior investors agree:

 

Source: Amel-Zadeh, A., and George Serafeim, 2017. “Why and How Investors Use ESG Information: Evidence from a Global Survey.” Working Paper.

However, some still vehemently oppose Sustainability/ESG. I call these the ‘alpha left on the table dogmatists’. They obsess about the areas we don’t invest in as an opportunity cost, blind to the evidence that this is more than offset elsewhere. I recently read some research which shows that clients hold sustainability analysis to a higher standard than other potential alpha factors. I quote: “clients want incontrovertible evidence that sustainability adds alpha before considering it”. This chimes with my experience and is convenient for the dogmatist because incontrovertible evidence can never be found. However, the empirical link between sustainable investing and alpha is strong. Downside risk protection is the most intuitive one and is the most commonly integrated ESG tool. We, of course, incorporate this into our investment process but we also take it further (again supported by empirical evidence) by recognising the following:

  1.  It creates the most alpha in the areas least covered. Emerging markets and small or mid cap companies.
  2. We look for growth stock improvers. Disruptive, innovative growth companies are much more likely to have a sustainable mind-set and be willing to engage – improve. These companies are also more likely to provide sustainable products and solutions. Thus, our three dimensions of product, process and improvement makes sense.
  3. Combining it with other risk metrics makes it even more powerful downside protection (also useful for short-selling).

Ultimately, investing is about employing an effective set of tools consistently in order to tip the odds in your favour. Sustainability analysis is one of these tools and it fills a key role in our toolbox, one which many investors don’t consciously utilise. So, sustainability is good and its alpha creation potential is backed by a growing body of research. But don’t be like Brian Fantana, remember that it doesn’t work 100% of the time, every time.

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 16 years’ industry experience (as at 31 October 2017).

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