John William Olsen, fund manager, M&G
In recent years we have seen a rapid acceleration in demand for a more responsible approach to investment.
This means that, alongside traditional financial considerations, investors are increasingly expected to take into account a broad set of environmental, social and governance factors that can affect an investment. These ESG factors can represent risks and opportunities, and there is a growing body of evidence that they can have a material effect on how an investment performs, particularly over the long term.
For institutions such as UK pension schemes with long investment horizons, a more ESG-aware
approach can offer the potential to mitigate a broad range of risks, from reputational damage to regulatory scrutiny, and support sustainable investment returns in their portfolios.
The principles underlying ESG investment are not new, but in recent years ESG-specific criteria has emerged as a dominant framework for assessing the long-term sustainability of a company or organisation.
As of February 2018, € 372bn was invested in ESG investment strategies in cross-border and domestic Europe, according to finance company servicing specialist Broadridge, up from € 132 bn in 2010.
There has also been strong growth in asset managers becoming signatories to the United Nations PRI (Principles for Responsible Investment). Signing up to the PRI includes the confirmation that investors will incorporate ESG issues into their investment analysis and decision-making processes.
M&G’s Select equities team integrates in-depth ESG analysis throughout its investment process, and actively engages with companies to encourage best practice or to help bring about positive change. Our approach focuses on long-term, sustainable investments. ‘Sustainability’ refers to the long-term durability of a business, and factors affecting that durability include the competitive landscape, industry structure and how a company is run as well as how it treats its customers, the communities in which it operates, its employees and the environment.
We believe that these considerations are a matter of stewardship, and a sensible part of any investment strategy aimed at maximising long-term economic returns. In our view, social consciousness and responsible management are important elements in many companies’ ability to generate economic value in the future, and that disregarding ESG factors could affect a company’s performance – as well as its share price.
We focus on three fundamental investment pillars – quality, deltas and valuation – which we view as integral to the overall investment return profile of the companies in which our strategies invest.
We think that ESG factors must be integrated within financial analysis, and these factors, as appropriate, are modelled within the three-pillar framework.
Quality: Moats (or the level of protection from competition) and sustainable business models – can include business culture, brand preservation and ability to retain talent.
Deltas: Long-term drivers and risks – may include energy efficiency measures for an industrial company, or supply chain monitoring for a consumer business.
Valuation: Probability-based scenario modelling – discount rate upward adjustment to factor in higher regulatory risks in utilities, for example, or potentially stranded assets in ‘asset heavy’ companies.
We believe that the importance of ESG factors should not be over-emphasised or under-emphasised. Those factors form part of the mix that needs to be considered alongside more traditional financial analysis, looking at all the relevant elements to make a more informed decision.
It is important to note that ESG research is not outsourced to a third party, but is undertaken by the Select team’s embedded analysts, with judgements on ESG factors not dissimilar to forming views on financial metrics. While some companies may score well or poorly on a third-party ESG rating system, we prefer to analyse those factors ourselves.
A medical waste disposal company, for example, may appear on the surface to fall down on systematic ESG criteria – but our research can uncover the positive impacts this company brings to society and the systems it has in place to minimise negative impacts, as well as its cash-flow profile and the evolution of its margins. We can also engage with that company to gain comfort in the sustainability of its business model or to encourage positive change – this is fundamental to our investment philosophy.
We engage with companies, not only to assess non-financial aspects, but also to advise on ESG matters and, again, to help foster change. This is important for a number of reasons, not least of which is an increasing body of evidence that shows engagement can have a positive impact on company performance. We believe that active asset managers can have significant influence on corporate behaviour and that, alongside like-minded investors, we will be able to strengthen corporate responsibility, culture and long-term performance of the companies in which we invest.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested.
