Investors can no longer afford to ignore sustainability
Sustainability is not a matter of investor preference. It describes process of change that is impacting on many aspects of our lives and in turn economies and financial markets. That's why it's an inherent part of our investment process
Firms’ response to the coronavirus crisis is telling
We started 2020 facing an environmental crisis. That hasn’t gone away: it’s just that now we are facing global healthcare and economic crises too.
As I write this, from my newly formed home office, I am watching in awe as the health services attempt to respond to the coronavirus’s spread; communities ground themselves to protect the most vulnerable; and central banks and governments try to fend off a sustained global recession.
This has clearly had meaningful implications for financial markets and our portfolios. However, the evidence so far suggests that portfolios constructed with sustainability in mind have outperformed the wider market during this extreme period.
We are not surprised by this outcome. History shows a correlation between high environmental, social and governance standards and equity returns. This correlation applies in severe downturns, such as we’ve recently seen, as in other times.
Sustainable companies are proving that stakeholder value is at the forefront of what they do, with moves to protect consumers, suppliers and employees during this turbulent time – by committing to cover child-care costs, for example, so that employees can continue to work while schools close; or designating vulnerable persons’ shopping hours, to ensure the distribution of goods to those who need to limit contact the most. These actions help protect the long term stability of the business by preserving consumer value, protecting supply chains and retaining staff.
These businesses are giving themselves the best chance of a quick recovery and a return to business as usual.
Consideration of environmental, social and governance factors is a crucial part of any investment analysis used to inform our investment decisions. This is the case when we’re acting for all clients, not just those who select a “sustainable” or “ethical” mandate. To us, it’s just us doing our job properly.
As a global investment manager, we recognise that we have an important part to play in shaping the future of all our stakeholders. Investment has a big role to play in solving the world’s shared problems. While that was true at the beginning of the year, it is even more the case now.
Portfolio Director and Sustainable Investment Specialist
A consideration of sustainability might have at one time been a matter of investors' preference. It is no longer. I say this based on what I see happening in markets and the direction of policy-making around the world. Social and environmental change is happening faster than ever. Climate change, shifting demographics and the technology revolution are reshaping our planet. Those companies that can adapt and thrive will be more successful in attracting customers, employees and growing their business.
These changes are taking place, irrespective of our personal views on the many aspects of this complex – and sometimes controversial – topic.
There is an instructive lesson in the impact of technology over the past decades. Investors who were slow to recognise the incredible potential of technological developments, and their implications for a wide range of other industries, have seen their relative performance suffer hugely.
Sustainability could become a theme that will dominate the investment agenda in a similar way in the decades ahead.
Impact on value
Investors cannot deny that issues relating to sustainability have unavoidable long-term investment implications. Climate change, which will require businesses across a range of sectors to operate in very different ways, is perhaps the most obvious example. But there are many other areas where thinking about environmental or social consequences can help us identify businesses which are well positioned for the years ahead – and those which are not.
For instance, in a world where consumers are increasingly aware of how goods are produced, it is incumbent upon us to consider the supply chain risks faced by consumer businesses that we invest in. Such analysis could well have an impact on our assessment of a company’s long-term earnings and risk profile, which are ultimately the key determinants of its value.
What does this mean in practical terms? Quite simply, we want to ensure that environmental and social factors are being considered within all investment decisions. This is equally true of companies in which we invest directly and fund managers we invest with.
Counting the cost of carbon
Percentage of earnings at risk from rising carbon costs
Source: Schroders, March 2019
In the case of a company, we want to understand the likes of how the business is positioned for a low carbon economy, how they are incorporating the technological revolution, as well as adapting for ever changing social behaviours. As an active owner, we use voting and engagement to encourage companies to improve their practices, using our scale to drive progress. This is not done out of altruism; there is clear financial benefit for us as shareholders.
By encouraging companies to reduce environmental or social risks in their business, we can help increase their long term value. Within fund managers, we want to see evidence that they are incorporating these external risks and opportunities into their own investment decisions, as well as how they themselves are engaging with the businesses in which they invest. Similarly to our engagement with companies, where we feel managers are behind best practice we will highlight our concerns and work with them to improve their approach. We feel this is the best way we can help protect our clients from external risks when investing through third party funds, as well as helping to improve responsible investment practices across the industry.
The tools we can use
Investing sustainably requires us to have significant insight into how businesses are being managed. The good news is that there is now far more information in the public domain. Listed companies are now required to disclose their carbon emissions, as well as data relating to many other environmental, social and governance factors. Regulators and other stakeholders are likely to keep companies under pressure to provide even more information.
Schroders has developed analytical tools which help us interpret this data. For instance, it is possible that at some point in the future companies will be made to pay for their carbon emissions, creating an incentive to keep them to a minimum. As things stand, this would represent a heavy cost to many companies and industries. As the chart above shows, we can now work out the impact of this on aggregate earnings at a national index level. Interestingly, the analysis shows that rising carbon costs would have the biggest impact on the UK market, which has a relatively larger exposure to extractive industries.
We recognise that some clients want to go further than managing their financial risks. Our specialist sustainability portfolios are designed for those clients who seek to invest for a better future by using their capital to drive progress. We can map portfolios to your specific impact objectives, avoiding harm, benefiting stakeholders and contributing to solutions. We go further than other asset managers, by including thematic and impact investments with measurable benefit to both people and planet.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.