Is there hope for emerging markets?
This article first appear on trustnet.com on 7th July 2022 Let’s be clear – anyone who has been...
It wasn’t many years ago that ESG was viewed as a niche area. Paying attention to a company’s Environmental, Social and Governance qualities was considered a quaint way to align investments with personal values – but certainly not crucial to returns.
However, times have changed. The world has woken up to climate change problems, social injustices and corruption, and is demanding companies are run in a responsible way.
Those who don’t make the grade face instant judgement in the court of social media. Today’s so-called ‘cancel culture’, can see individuals and companies ostracised virtually overnight.
Of course, these are all pretty negative reasons for embracing ESG. But there are plenty of positive reasons to consider this area too – as evidenced by the growth in interest from investors.
Investment in UK green and ethical funds grew significantly last year, according to figures compiled by the EIRIS Foundation, a charity that promotes responsible business and investment.
It found there was £33.5bn in this area – up from £25.3bn the previous year – which it attributes to a growing demand for products incorporating consumer concerns*. Philip Webster, the foundation’s chief executive, said: “This growth reflects a sea change in consumer and wider stakeholder interest in green and ethical finance.”
As well as promoting better practices, there’s also a positive link between a company’s sustainability characteristics and the dividends it pays out, according to research by Fidelity International.
Analysis of Fidelity’s sustainability ratings, which grade 4,900 companies from A to E, shows a strong relationship between historical dividend growth and ESG quality. On average, stocks rated A for sustainability had the highest levels of historical dividend growth – at over five per cent – with D and E rated stocks offering the lowest average levels of growth.
According to Matthew Jennings, Fidelity’s investment director, ESG leaders are more likely than ESG laggards to offer attractive levels of dividend growth over the long term.
“Good management of environmental and social risks (and opportunities) tends to help companies avoid higher regulatory costs, litigation, brand erosion and stranded assets,” he said. It’s also a benefit when it comes to company management. “Strong governance reduces the risks associated with over-leveraged balance sheets or risky, value destroying M&A,” he added. “This protects profits and allows them to be paid out to shareholders as dividends.”
Companies in sectors with structural sustainability issues may face weaker dividend growth, according to the Fidelity report. “Oil majors Shell and BP both significantly reduced dividend distributions last year to fund the transition to lower carbon assets,” pointed out Jennings.
By contrast, utilities with renewable energy operations are benefiting from regulatory and investment tailwinds. “Enel, one of the earliest utilities to invest a lot of money in renewable energy has committed to seven per cent annual growth in dividends through to 2023,” he said. Separately, Unilever – another business Fidelity rates highly for sustainability – has a record of long-term dividend growth, which is around six per cent annualised over 20 years.
In the current climate, most investment managers will need to consider ESG factors when they are looking for stocks with which to populate their portfolios. However, there are plenty of funds that have specific responsible investing mandates that will be even more pre-disposed to those types of companies.
The EdenTree Responsible & Sustainable UK Equity fund finds companies that are currently undervalued and out-of-favour, but with the potential to increase in value.
This portfolio has been under the stewardship of Sue Round since it was launched back in 1988, making it one of the first ethical funds in the UK. Responsible investing is a key factor in her – and co-manager Ketan Patel’s – decision making, with any potential investment having to pass through a rigorous multi-factor screening process.
The aim of the fund is to achieve long-term capital appreciation over five years or more, as well as an income. It looks to invest in a portfolio of companies that make a positive contribution to society and the environment through sustainable and socially responsible practices.
The stated objective of the BMO Responsible Global Equity fund, which was launched in March 1998, is to provide long-term capital growth. It does this by investing in companies screened against defined responsible and sustainable criteria, including exclusions on tobacco, alcohol, weapons, gambling, nuclear and pornography.
In addition, the portfolio, which is managed by Jamie Jenkins and Nick Henderson, requires companies to meet a variety of sector standards on social and environmental impacts. These include systems for managing labour standards, human rights, supply chains, environmental impacts, water, waste and biodiversity.
While the fund avoids companies with unsustainable business practices, it will consider investing in those where problems can be resolved. In addition, BMO’s responsible investing team is a separate unit of the company, which means it can provide bespoke, independent analysis.
Austin Forey is manager of the JPMorgan Emerging Markets Investment Trust, which seeks high quality companies with the potential to deliver sustainable long-term returns. “Investing sustainably has always been an integral part of our research and investment approach, well before ESG factors became mainstream,” he said.
Key sectors are never part of the portfolio. “We don’t hold, for example, energy stocks and miners, and haven’t for a long time,” he added. He pointed out that the carbon emissions of the trust’s investments amount to a mere one twentieth of that of the MSCI Emerging Markets Index. “The trust’s portfolio naturally tilts towards industries with a significantly better-than-average carbon footprint, to use a common environmental yardstick,” he added.
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*Source: EIRIS Foundation, 26 October 2020