07 May 2020
The long shadow of a pandemic is making us all challenge our assumptions and rethink what matters in life, including our investments. In recent years many investors have turned to sustainable investing, paying particular attention to environmental, social and governance factors, but does ESG still seem so attractive in a locked-down world?
Most of us invest to achieve financial security, especially through retirement, so investment performance has a critical impact on our wellbeing. As committed sustainable fund managers, we have long been concerned that ESG might merely be a ‘nice-to-have’ that many would abandon when the bull market crashed.
For the trend to last, ESG has to make a positive impact now. What happens in a period like this matters hugely, as many years of good performance can be lost in a very short space of time during a bear market. This is why, as pragmatic investors who suspect that ESG can frequently become an over-elaborate box-ticking exercise, we are intrigued to see which of the three components has most influenced performance. The early indicators are interesting.
‘Environmental’ encompasses a wide variety of issues for different industries. This may explain why it has had such mixed performance. Environmentally positive companies that we hold – such as wind farm manager Ørsted, which is in a sector that is enjoying secular growth, is not dependent on government subsidies and has prudent debt levels – have performed fine. But being in water, waste and energy management has not helped Veolia Environment (not a holding).
In truth, the greatest benefit of managing a portfolio with a positive environmental slant is often what it keeps us away from. Just avoiding airlines, for example, has been a boon to relative performance for us and other sustainable managers. Yet it may not continue to work in our favour. Electricity demand has dropped, and wind power is no longer at the bottom of the cost curve as fossil fuels prices have plummeted.
In addition, the environment might not remain the priority that it has been for governments (not sufficient a priority, some would argue, but it has had a big influence on public policy). Policymakers are still pushing parts of the ‘Green Deal’, and these may yet prove a popular element of any stimulus package, but it is worth noting that the Glasgow Climate Summit has been among the casualties of Covid-19. Although the momentum and goodwill required to push this agenda are still strong, governments may soon focus more attention on problems such as rapidly rising unemployment or, indeed, the increased provision of healthcare.
Most companies are signalling their social credentials during the crisis. Hardly an email lands that does not ask after the addressee’s health. No corporate announcement fails to put the safety of staff, customers and suppliers first.
Companies such as top-10 holding Louis Vuitton – which quickly reversed a decision to tap state aid and has turned from making handbags to manufacturing hospital masks and gowns – have always placed great emphasis on such elements. They are coping reasonably well with the current challenges and fostering enduring loyalty from customers and staff alike – an approach that should reap rewards later.
By contrast, companies that have been shamed in this crisis may face a backlash when normal life resumes. Certainly as investors, we will remember how companies behaved in this period.
It is in governance where the principal beneficial impact of ESG has been felt. Well-governed companies have regard for issues like diversity (as do we – how many women are on a board is a useful barometer of how good a company is at managing and promoting talent).
The key governance issue right now, though, is prudent financing. It is in a crisis (and during its aftermath) that you see how resilient a company is. Those arguing that running debt at three times EBITDA was not risky have in many cases been made to look foolish, especially in more cyclical areas. The merits of resilience in terms of strategy and balance sheet are now very evident. Those who have chided the Japanese for fortress balance sheets over the years might now think again.
Increasingly, another major issue in governance is whether companies are able to work for shareholders or whether they have been co-opted to work for the state. Governments’ commands that companies should not pay dividends that they can clearly afford – as witnessed in France and, sadly, the UK – downgrade the capitalist system. Shareholders should not be expected to show support in normal times if they are milked in times like these. It seems ludicrous that a Chinese bank is more reliable for dividend income than a British one.
Share buybacks are a common way of rewarding investors in the US. They are down 20% so far this year. Boards are arguing that preservation of capital is vital, but this says little for whether it was a good use of capital to buy back shares when markets were higher and not do the same now. How companies treat their shareholders is going to become a vital issue in the months ahead.
Issues that have been in the air for some time often become more urgent in the face of crisis. In turn, this can lead to society accepting radical change. We have known for years that the pollution we generate through travel (especially air) is simply unnecessary. We have known for years that we cannot endlessly put plastic into the sea.
I do not think this crisis has dented the enthusiasm for investing with principles. It is proving what we had already surmised – that E, S and G are important to the financial performance of companies and their share prices but that when markets turn rough it is good governance that matters most of all.
ESG is not the only factor in investment performance, of course. It matters, too, if you are in sectors that have the wind in their sails. Our thematic approach, aligned with a pragmatic attitude to ESG, has helped capture these secular trends in areas such as online services, healthcare and automation and has meant that YTD (30 April 2020) we have outperformed the MSCI world index by 8% on the Mid Wynd International investment trust and 5.8% on the Artemis Global Select unit trust*.
We still think principled investing need not be complicated. We have always said that investors should buy well-governed companies that can look after themselves and that they should avoid oil, airlines, cyclicality, leverage and government support. We call this approach ‘sense and sustainability’. Past performance is no guarantee of future performance, but so far in this crisis the process is working.
Alex Illingworth co-manages the Artemis Global Select Fund and the Mid Wynd Investment Trust.
*Past performance is not a guide to the future. Source: Lipper, class I GBP accumulation units from 1st January to 30 April 2020. The Artemis Global Select Fund returned -2.8% and the Mid Wynd International Investment Trust returned 0.6% during the period from 1st January 2020 to 30 April 2020. The MSCI AC World NR GBP returned -8.6% during the same period. All figures show total returns with dividends and/or income reinvested, net of all charges. Performance does not take account of any costs incurred when investors buy or sell the fund. Returns may vary as a result of currency fluctuations if the investor’s currency is different to that of the class. This class may have charges or a hedging approach different from those in the IA sector benchmark. Benchmark is the MSCI AC World NR GBP. MSCI AC World NR GBP Index
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