Why is there so much focus on ESG at the moment?
ESG has definitely passed a tipping point over the last 12 months, with everyone talking about it now and lots of momentum behind it.
In reality we have been applying ESG factors, along with lots of other material factors, to investment portfolios for years. But the Department for Work and Pensions’ requirement for trustees to include their ESG approach within their statement of investment principles (SIP) has been a catalyst for change, forcing the issue to the top of the agenda.
So what change has the new focus initiated?
What is different now is that the momentum behind ESG is making managers more likely to act upon those decisions and switch from low-rated ESG assets to higher rated ones.
Take the energy sector – analysts have been thinking about the concept of stranded assets for years, but have not been taking serious steps to get out of potentially unsustainable assets. The noise around ESG has nudged managers to take more concrete steps to consider the companies they hold in the context of ESG risks or opportunities and make adjustments.
What does this new ESG approach mean for pension investors?
A good example is the deep dive into the UK gas sector recently undertaken by the managers on our Sterling Credit Fund, which is held within our Governed Range. The fund holds bonds of several of utilities including gas. But with the UK government committing to a legally binding target of net zero carbon emissions by 2050 it is clear some utilities have better future prospects than others.
There is a perception in the credit market that utilities are relatively stable assets and therefore low risk. Our analysis showed us that some gas businesses could become stranded assets in the future, and that we could get the same yield from electricity utilities that do not face the same long-term sustainability risk.
We are seeing an increasing amount of ESG data and an increasing number of providers. Is that making the manager’s job easier?
There is certainly a proliferation of ESG data, and a growth in providers, and much of what they generate is informative. The nature of ESG data is changing rapidly, with new data providers doing real-time scoring of companies, by scanning the internet for stories about companies. So these days if companies say one thing about their ESG approach but do another, they are a lot more likely to get found out.
But off-the-shelf data is no substitute for deep analysis by an active manager. Going back to the gas utility example – we could not have made the call we did on the basis of off-the-shelf ESG data.
This is partly because ESG data providers tend not to have much data on private or not fully public organisations such as utilities. But also because a manager can only make a call of this sort after doing a lot of deep thinking about the issues and talking to the companies themselves.
Does an ESG approach deliver better returns?
Virtually all the data we have analysed shows that there is either a positive or neutral impact on performance from having an ESG approach.
To what extent do moral and ethical factors play a role in ESG investing?
It’s too simplistic to discriminate between ‘moral’ risks and pure financial risks.
For example, you can have a tobacco company that ranks highly on ESG because of its employment practices, soil management and other factors, even though the end product it creates is harmful. If an investor or trustee wants to exclude investments in tobacco across the board, that would be an ethical or ‘exclusions’ approach, not an ESG one.
How can trustees and advisers know if a fund operates a genuinely robust ESG process.
Unfortunately there is a lot of confusion about definitions and terminology. The fund’s name will not always reflect what a fund actually does on ESG. You need to look under the hood.
Adopting ESG is not about putting a marketing wrapper around an existing product. It requires a deep understanding of ESG issues and changes in processes. The best way to do ESG effectively is by active management and stock picking.
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