Greetings and welcome to Issue #1 of Impactful Investing!
Please feel free to sign up and share as the more investors that achieve a meaningful return with impact the better for all.
This issues provides a quick summary of what responsible investment is,
It will address what differentiates “impact investing”,
Why Donald Trump doesn’t like Responsible Investing,
How the returns fare against the traditional peers that have not taken into account the ESG facets during the current Covid 19 pandemic.
So what exactly is Responsible Investing?
The action of responsible investing is the practice of incorporating environmental, social and governance (ESG) factors in investment decisions and active ownership. This is sometimes incorrectly deemed the non financial component in the process of determining a businesses intrinsic value. ESG factors are can be both financial and non financial factors.
What are some examples of ESG factors?
Environmental
climate change
resource depletion
deforestation
Social
human rights
modern slavery
child labour
Governance
bribery and corruption
executive pay
board diversity and structure.
So what is Impact Investing?
Impact investing refers to investments "made into companies, organisations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return". Impact investments provide capital to address social and/or environmental issues. Impact investing has the potential to transform our ability to build a better society for all. This is where the author sees the greatest growth FUM will be invested over the coming years and the areas to be greatest interest. How can anyone not be interested in returns with positive societal outcomes.
There has long been a debate between those who regard environmental, social and governance (ESG) factors as being risk factors which can have a material impact on investment performance and those who regard them as exclusive social issues. However, the evidence of materiality with regard to ESG factors is beginning to take shape as more academic and practitioner research emerges and a market correction of 27% in the space of 35 days can be analysed.
Each and every major downturn in the share market evokes a question from my crew of friends and colleagues pertaining to, how ESG funds have held up. Essentially, they are asking did an ESG fund perform better. I like to respond with my own question “what return does your fund need to attain to get back the gains lost during a correction?” At least this will ensure they think historically and also with regards to the future ie. what have I just lost and what does my fund need to return to recover the losses.
Naturally, performance speaks loudest for most investors. To be clear the ESG Funds and their associated stocks that can be included within a typical ESG fund fell and fell heavily just like those stocks that are within a traditional fund that does not specifically take into account ESG tenants. As an ex portfolio analyst, I like to rely upon the numbers. As A.Pittard used to say, “the numbers don’t lie”. On a global basis, Dow Jones data shows 150 out of 200 ESG-focused share funds out-performed their peers for the year to date. Now that is at the fund level where there are so many variables like cash levels. Specifically, its best to review the stocks. Using the Fidelity Integration metrics ESG stocks performed nearly 4% better than the wider market index over the period and those stocks with poor ESG ratings did 7% worse.
In short the ESG funds have outperformed. Now before someone asks specifically Why? I suggest that you consider that ESG funds typically have a larger exposure to technology and an under weight to that of Oil and Gas. Yet that simplifies the discussion. The real out performance is due to the ESG Funds taking more consideration of stock specific risks than a traditional fund manager. They considered those stocks that belong in a portfolio for a “responsible investor”. The responsible investor has been rewarded for taking risk out of the portfolio. The portfolio manager has been rewarded for considering a longer term view they the traditional 3-5 years and considering perhaps a longer term view of greater than 10 years. Well done to those investors that consider responsible investing.
In a recent webinar, Mercer partner and global business leader of responsible investment Helga Birgden confirmed that there is an emerging trend of outperformance in comparison to other fund management styles. Global fund manager AXA Investment Managers found that companies with higher ESG ratings performed "notably better" and showed better resilience during the outbreak of the coronavirus pandemic compared to investments with lower resilience. AXA IM's research shows that ESG leaders outperformed ESG laggards by 16.8% in the first quarter of 2020.
In my own words as an ESG investor and portfolio analyst with 20 odd years behind me. ESG investors simply consider more risks than traditional analysts. An ESG analyst is also required to determine a valuation of a stock and whether it is trading above or below its intrinsic value and what factors will force the market to realise that value. Yet the difference is that an ESG analyst has a more realistic valuation after discounting or inflating the value due to the components of ESG.
The future bode very well as more and more fund managers take into account of ESG factors and moved beyond exclusions to a full and complete analysis of a company’s risks and opportunities. The came along Donald Trump.
After a remarkable run of success in the investment sector, ethical investing has received an unwelcome jolt from the US government with a Trump administration proposal to remove so-called Environmental, Social and Governance (ESG) investments from retirement funds.
With the policy-making US Department of Labor controlling funds representing one third of the entire US sharemarket - the announcement has sent shockwaves through the global ESG sector.
Meanwhile, investment research group Morningstar warned: “The Trump move could conceivably spark similar measures by other regulators in the months ahead.”
With funds of $US9 trillion ($13 trillion) under its control, the US Department of Labor says that fund managers acting on behalf of American workers should only follow “objective risk criteria” when buying stocks and bonds.
In essence, the proposal puts forward a hardline traditional view of investment objectives where the sole purpose of retirement funds is to make money for members.
Opponents of ESG investing - including companies in the mining, defence and tobacco that have been sidelined by ESG consultants - regularly argue superannuation funds should not be run based on ESG factors. But the US attempt to order investing based on “objective risk return” stands as one of the first official policy measures that could set back an industry that has thrived in recent times as “clean” technology companies have spearheaded outperformance by ESG funds over conventional funds across the market.
The irony of Donald Trumps view is that greater analysis and risk awareness occurs when you take into account ESG factors. It is the authors view that each and every stock should be reviewed against ESG factors and certainly more than exclusion filters.
I would suspect substantial kickback regarding the proposed ruling both from fiduciaries and investors - and its with interest we wait to hear from the Union-linked industry funds, particularly those that have been pushed to achieve social and environmental objectives through their wider investing activity. What a tough job trying to figure out how to reduce your exposure to carbon emitters when your members are coal miners. Yet there is solutions and many - sign up to the newsletter for more.
Disclaimer notice
The information contained in this investment note is meant for informational purposes only and is subject to change without notice. The content is provided with the understanding that the authors and publishers are not herein engaged to render advice on legal, economic, or other professional issues and services.
A very thought provoking and insightful article. This will be interesting to see how people’s enlightened investing preferences will dictate the investment landscape over the coming years. Greg Pearce.