We’ve been very forthright about why we think Socially Responsible Investing (SRI) is the future. We believe this now more than ever. The advent of the ‘new normal’ emphasises the imperative for changes in finance and economics as much as it does for social interaction and transport.
The UK has seen its GDP shrink by 20.4% in Q2 of 2020, a contraction worse than any other G7 nation, while the central bank, the Bank of England, has warned of unemployment rising beyond 2.5 million and the worst recession in living memory. Globally, the World Bank expects world growth – as measured by gross domestic product (GDP) – to shrink by over 5% in 2020, far exceeding the slowdown experienced during the financial crisis and representing the deepest recession in our lifetime1.
None of this is surprising given the scale and systemic nature of the covid pandemic. Indeed, it could have been a lot worse had we not had the financial regulations that were installed after the last great financial crisis. However, while the pandemic has put an onus on businesses and governments globally to work together for a swift return to profit and growth, it has also highlighted unsustainable and opaque supply chains, inefficient business models and divergences of customer and corporate interests. The pandemic has rightly been identified as a once in a lifetime opportunity to review and improve all sorts of processes, protocols and mandates – investing is no exception.
Time for SRI
In our view, the case for SRI was well documented before the pandemic, however the reality of short–term planning, overstrained systems, imbalanced economies and social discontent that the pandemic has helped fuel, underlines the case for investors to recognise the importance of environmental, social and governance (ESG) considerations in the pursuit of sustainable long term returns. And, if the structural factors highlighted by the pandemic fail to attract the required attention, it’s possible the performance of socially responsible investments before, during and after the pandemic will.
Source: MSCI
In fact, when we compare global stock market performance since the end of 2007, we find that socially responsible stocks have outperformed the wider market not only on an absolute basis, but also with a Sharpe ratio 16% higher than that of the global stock market. That means less risk, and more reward. Fast forward to 2020 and we find that over the previous 12 months the returns for global socially responsible equities are nearly 80% higher than those for the wider index, while volatility again remains lower.
But it is not just performance that is helping socially responsible investment approaches gain traction. SRI is of its time and growing in popularity because it allows a greater alignment of an individual’s investments with their personal values and the wider goals of society. This mirrors the broader empowerment of the individual commercially, a change driven by the digital revolution and powered by ever more transparent and detailed data sets. As a result, investors, both individual and corporate, have increasingly recognised their societal responsibility to prioritise greater ESG outcomes in the investment landscape – and the critical role capital allocation plays in this.
We saw this most prominently last year when Larry Fink, CEO of the world’s biggest investor, BlackRock, wrote a letter to clients telling them the firm would only seek to invest in companies that adhered to certain ESG standards and would move money out of major polluting industries. More recently HSBC has scrutinised their investment in the world’s largest meat processor, JBS, following their reluctance to amend their destructive practices in the Amazon.
The power behind the decisions made by BlackRock and HSBC is something we all hold: the Make My Money Matter campaign has rendered this message brilliantly, letting people know that their investment choices can have real, lasting consequences – ‘invest for the world you want to retire in’, could not be more apt, especially in the age of Covid, and leads perfectly into the second argument for SRI.
Being part of real change and real returns
SRI is driving a shift in the way investors of all types consider the concept of sustainable long-term returns. SRI has activated an industry to fundamentally re–evaluate its perception of long-term success and its role in society. A deeper connection between the profit and loss in the world’s financial markets and longer–term societal harm has been created – this is no longer a periphery consideration. Non-financial data has a more meaningful place – one that puts a value on variables that currently don’t have monetary value: a new numeraire.
Meanwhile individual investors too are waking up to the real-world impacts of their investments. They are recognising that as owners of companies – whether through their retirement savings or otherwise – they have a choice about values alignment and the opportunity to make decisions that lead to significant contributions.
We recently explained this phenomenon with a calculator that explored the ownership of carbon emissions, revealing that by choosing an SRI approach as opposed to a portfolio of global equities, an individual investing just £20,000 could save the carbon equivalent of 10.2. return flights from London to Barcelona every year. Expect to retire with £200,000? That’s the equivalent of 102 return flights from London to Barcelona saved per annum in carbon emissions.
The key to unlocking this behaviour is empowering knowledge. We are gaining better data sets across a wide range of non-financial metrics, and once we begin to measure something, then we have the ability to shape our behaviours accordingly.
Source: Nutmeg / MSCI
Below is another illustration to help visualise the carbon savings you can make by choosing SRI compared to a pool of global equities:
Approaches such as socially responsible investing can give us all the much-needed retort to the sense of powerlessness when it comes to the systemic changes we know the world must make, but feel our leaders are unable to enact. However, the realisation is growing: our research suggests 35% of investors would change their portfolio over concerns regarding the business ethics of the companies they were invested in. In regard to environmental issues that number rises to 39% and to 54% concerning human rights abuses.
Investment is responsibility. That runs parallel with the recognition that in life there are only so many sacrifices we can make. However, our financial lives are a hugely powerful aspect of our ability to make a difference. Rightly, education on environmental, social and governance issues (ESG) and clarity on data have driven a desire to tackle this untouched but potent area of our lives. For example, pensions are among the biggest lifelong financial commitments we make as individuals, usually representing the single biggest investment we will ever make. Yet few of us realise how we can make this investment deliver on our values, working, as we all want to, towards a better world – the one in which we want to retire, not the one we feel we need to financially hedge against. This decision, we believe, requires little in terms of trade–off in financial outcomes to make such a significant impact.
The bottom line is no less important
This brings me to the third core tenant of SRI: it can be profitable. SRI enshrines rational and considered approaches; responsible and sustainable growth; new sustainable markets; efficient and environmentally conscious production not prone to state levies; transparency and good internal governance. These are all principles that any company would hold up but, without the stated mandate of investor interest, too few believe they have cause to – ultimately making them poorly guided and vulnerable to market forces.
By using an ESG lens, SRI empowers a truly long-term approach, one that most investors acknowledge but that few deeply embed in their current analysis. The concept is similar to blinkers on a horse: the distractions of the current environment remove focus from the end goal.
Take, for example, industries involved in the extraction of fossil fuels. It is widely understood that we are well into a long transition away from a fossil fuels-based economy. The end of fossil fuels is nigh within our lifetime and it is clear that existing fossil fuel reserves will never be fully utilised. Yet the valuation of so many energy companies still relies on this. In recent years, the recognition of this transition by policy has put a premium on green technologies and ecological consideration at every level of business. Climate risk is becoming critical risk consideration across industry, as businesses grapple with its long-term costs and effects. As an indicator of the robustness of the green tech market, in the last 12 months the UK sourced 62% of its electricity from non-fossil fuels, 26% coming from renewables.
We are closer to a global carbon market than we have ever been: carbon has become tradeable and its real costs, through policy and economics, are increasingly being borne by its producers. More broadly, climate change is beginning to have real world impacts through disruption and rising operational costs. As carbon pricing becomes a reality in the coming years, so too will the reality of fundamental change for carbon intensive business models. The long–term nature of ESG analysis helps investors to focus on long–term shifts rather than just short–term trends – an invaluable insight to have in the time of pandemic.
How ESG makes for better investing
ESG is not a blunt interpretation of huge systemic variables; its power lies in its innovative nuances and materiality. It recognises that in assessing the relationship between ESG issues and financial performance, not all ESG considerations matter equally within an industry or in the same way across industries. While ESG perspectives are necessarily holistic, investors seeking deeper ESG integration do not simply seek to improve all aspects of a business from an ESG perspective – they specifically seek to assess the risk and improve the alignment with those issues deemed most material to the company and to the sector it operates in. In simple terms, this means caring more about pollution and carbon intensity in energy businesses and data privacy in technology companies, rather than treating all factors equally. But it is also about understanding a company’s management of these risks, relative to its peers – with the principle that more exposure to a risk that is well managed maybe a more attractive long–term position than less exposure to a risk that remains unmanaged.
In this regard, ESG frameworks provide investors with another lens through which to differentiate companies by virtue of their ESG alignment. And the results of this can be surprising to many.
Despite the stellar performance of the socially responsible global equity universe in the previous 12 months, many investors are surprised to learn that of the popular FAANG stocks – Facebook, Amazon, Apple, Netflix and Google – none currently make the cut, despite their stock market leadership and popular consumer brands. Rather, the largest technology constituents are Microsoft and Nvidia, both companies that perform well relative to peers on critical issues such as human capital development, development of clean technology and corporate governance.
In my conversations, clients often seem most surprised by Apple’s omission given the popularity of its products and perceived clean image. And while Apple is by no means a poor performer from an ESG perspective, its dependence on supply chains in regions with poor working practices and engagement in anticompetitive practices in multiple markets, mean it is not a leader.
Other ESG lenses draw out the values–focused comparisons retail investors are less likely to make – those which are more fundamental to the way in which businesses derive their revenues. Our investments in UK socially responsible stocks currently exclude the supermarket Tesco, for instance, but include Sainsburys. While both companies have issues surrounding labour management and product safety, both retain a relatively strong overall ESG profile. But it is Tesco’s share of revenues from tobacco products of over 5%, that leads to its exclusion.
Ultimately, the ESG lens that mandates SRI is existentially relevant to growth. ESG as a model of analysis prescribes some of the great problems that are facing the world today: the need for social enfranchisement, ecological protection and the promotion of efficient, innovative and flexible working practices. These are all issues that have been sharply highlighted by the global pandemic, the last being particularly prominent as working practices have been turned upside down. The pandemic has worsened inequality and heightened the need for change. Worse still, the recovery will likely be one of the most uneven we’ve ever witnessed, further increasing disparities. Such disparities, as measured by ESG, may well give us an indication of the parameters which will describe the next great global event.
These problems are opportunities. By investing in companies best placed to address them, we believe our clients are investing in the greatest potential to be successful while remaining aligned to societal progress – investing in companies that conduct business in a fairer and more progressive way, that strive to be leaders in more than just profit. Likewise, by avoiding those companies that are complacent when it comes to ESG or controversial or damaging activities, we are mitigating long-term risk as their appropriateness declines. In every sense, we believe SRI defines the real meaning of investing for the future.
You can make a difference today and start your SRI journey with a Nutmeg ISA.
If you’d like to know more about Nutmeg and SRI you can read our white paper here.
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Risk warning
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance. Forecasts are not a reliable indicator of future performance.
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James McManus
James joined Nutmeg in 2015 from Coutts & Co. He is responsible for leading the investment management, wealth services, and investment proposition teams at Nutmeg. An expert in exchange-traded funds (ETF), James is regularly quoted in the national and industry press on ETFs, investment funds and ESG investing, and was voted one of Private Asset Manager’s Top 40 under 40, five times between 2017-2021. James holds a BSc in International Business from Nottingham Business School, the CFA UK Investment Management Certificate, and the CFA Certificate in ESG Investing.Other posts by James McManus