By Sebastien Thevoux-Chaubel
For many investors, the march towards ESG integration looks like an obvious choice in principle. However, it can become a bit more complicated once they start to look at the nitty gritty details of its concrete implementation. In order to really judge asset managers on whether ESG factors are fully embedded in their investment approach, investors should ask them three questions: how does ESG fit into your financial investment process and why? Are you sincere and consistent in its implementation? And will I get any financial returns from this?
These questions are critical but hard to answer because they require having a long term focus on value creation in order to be relevant. Most ESG considerations do not have material financial benefits over a few quarters. They generally start to matter over three to five years, or more, and just a handful of asset managers can afford to think over such long time frames. The most critical part is the ability to understand the value creation process of a company and what its dependencies are. For instance, textbooks rightly assume that outstanding and durable excess returns are rare and can only be derived from genuine and lasting innovations. But innovations are very hard to forecast and the capacity of a company to create them repeatedly is equally difficult to grasp.
As a matter of fact, sustainability is a good proxy for innovation capability as the commonalities between the two are striking at a company level: both require empathy and care for stakeholders, a clear capacity to anticipate future needs and a strong ability to adapt smartly, over time, to a constantly changing environment. In our experience, those companies which have a culture of excellence embedded deep within their DNA exhibit the best strategies and performances around innovation, as well as and sustainable development. Examples of this would be global healthcare company Novo Nordisk, fashion retail group Inditex, multinational software company Dassault Systèmes and US-based medical technology company Becton Dickinson. In emerging markets, Taiwan Semiconductor Manufacturing Company (TSMC) exhibits these same attributes of innovation and sustainable growth.
To succeed, such a combination is most often enabled (and subsequently perpetuated) by a strong business purpose that will help all employees, from top to bottom, be highly engaged and find the best way to reach the goals set in the strategy, no matter how uncertain and complex the business surroundings may be. A long term oriented management team, backed by a challenging but very stable shareholding structure usually helps. To create innovations that generate monumental profits, a pre-condition is to make the most of one’s employees. Companies have a responsibility to help their employees realise their potential through respect, accountability, resources and a clear set of goals which make sense within the overarching strategy of the company. Lastly, if the true purpose of a company is to address some of the most pressing challenges of civil society, then it is very likely its customers will provide it with high growth and returns enthusiastically. To understand and measure all this requires the analysis of the culture of a company. This can only be done through in-depth ESG scrutiny of its HR strategy and governance structures. Relating this analysis to financials can be difficult, but it is rewarding when assessing long-term growth potentials.
The processes involved in ESG integration may include regular onsite company visits, often including additional meetings with independent board members, middle management and employees to gain a clearer picture of a company’s culture. A programme of closely monitoring companies should be embedded into the process, with a focus on highlighting ESG issues which may materially impact investments.
All these inputs feed into an understanding of how a company thinks and adapts to its changing environment. These analyses show that, in any given sector, some companies are more resilient than others and an asset manager can adjust its discount rates for this. Likewise, some companies are better positioned to capitalise on trends and opportunities, which will be naturally be reflected in higher revenue projections.
ESG integration naturally fits into a long term quality growth investment strategy, as it can reveal the quality of a company, while sustainability, just like innovation, can secure its growth trajectory and its returns for longer. When applied in a systematic and thoughtful way, focusing on ESG factors has been proven to offer investors sustainably strong long term returns.
Sebastien Thevoux-Chaubel is an ESG analyst & portfolio manager at Comgest
