Many more investors are focusing on how their portfolios – whether ‘strictly ethical’ or not – align against environmental, social and governance (ESG) criteria. In this blog post we outline our own reasons for becoming one of the first wealth managers to offer ESG scoring for all our investment portfolios.
What’s the cost of an unhappy workforce? What role is water stress likely to play in the supply chain? What’s the effect of lack of female representation at board level? These questions are not ones captured in traditional financial analysis, yet all have a material impact.
At Nutmeg we believe ESG considerations are fundamental in making informed investment decisions. And to help you understand how your portfolios align with ESG criteria, we score all our portfolios – not just our socially responsible ones – on socially responsible metrics. So why do we think investors should pay attention to ESG issues? Our reasons for doing so are clear…
An ESG-focus can drive better financial performance
It’s often assumed that investing with a socially responsible bias necessarily means a trade-off in performance. The evidence says otherwise.
Read more: How do socially responsible portfolios perform?
In a widely cited meta-study of 2,200 studies on the relationship between ESG and corporate financial performance, 90% showed either a positive or non-negative relationship between the two. The business case for ESG then, in the authors’ own words, “is very well founded”.
The premise is really quite simple: companies that score highly on ESG factors understand that managing environmental and social factors can reduce costs, mitigate risks and create additional revenue-generating opportunities.
Analysing companies through an ESG lens can be a differentiator in and of itself. Evidence shows that doing so can generate better long-term financial performance across a range of metrics – including sales growth, return on equity (ROE), return on invested capital (ROIC), even alpha.
ESG analysis helps manage systemic risks
Recognising ESG factors isn’t simply ‘doing your bit’ or ‘being a good citizen’. A more calculating individual might say it’s just as much about identifying and managing systemic risks.
Exposure to climate change or unstable commodity prices, for example, can indirectly or directly affect investment returns. A manufacturing company that fails to recognise the impact of climate change on precious raw materials will likely suffer in the long term. So too will a car company that fails to plan for the shift to a low carbon economy, or an oil and gas company that ignores stranded assets.
Read more: Why water stress matters to investors
The 2015 Volkswagen scandal,when devices were fitted on cars to cheat emissions tests, was a lesson in the value of ESG analysis in predicting collapse.
Shortly before the scandal broke, MSCI, whose data we use for our own ESG scoring, noted that VW’s poor corporate governance record merited its removal from the MSCI ACWI ESG Index. Later, the company would shell out billions in fines and its share price would dive 40%, arguably due to failings of governance throughout the organisation.
ESG funds hold up better in a downturn
The Covid-19 crisis is many things to many people. For the purposes of this blog post, it’s an opportunity to test the resilience of companies with high ESG ratings versus those without. The signs so far are positive.
While some commentators – Ryanair’s Michael O’Leary included – have suggested the market fallout will kick ESG down the list of investor priorities, the numbers say otherwise. In fact, ESG funds saw record inflows in the first quarter. These came despite a memorably challenging month in March.
Over the same period, Morningstar reported 51of its 57 sustainable indices outperformed their broad market counterparts. MSCI reported that 15 of its 17 did the same. And BlackRock reported that 94% of its sustainable strategies outperformed their parent benchmarks.
The coronavirus has only emphasised the importance of ESG criteria in enduring a downturn.
ESG indices look beyond the short term
An ESG-focused approach fits neatly with our belief at Nutmeg that the best approach to investment is one that is long-term in nature.
Read more: The facts about long-term investing
Companies that lead in ESG best practice are less susceptible to short-termism and “profit at all cost” thinking. Shareholders still prosper, though not at the expense of people and planet – and usually over a longer time horizon. It’s a simple premise: those who do business in a fair and progressive way are better positioned in adapting to long-term, fundamental and/or transformational changes.
Meanwhile, those involved in controversial and high-risk activities should expect to encounter threats in the form of regulation, dwindling consumer sentiment and climate change. Bankruptcies and the general malaise in the coal and thermal coal sectors is a classic case in point.
ESG is the future of investing
Radically transparent, focused on the long-term and encompassing not just what’s good for returns, socially responsible investing meets our criteria for what the future of investing should look like. ESG considerations are central to that belief.
Read more: A guide to socially responsible investing
The world is changing. Powerful forces, from climate change to a global policy focus on a fairer society, are trends likely to reward companies with preferential ESG profiles relative to those without. The world’s largest investors are moving away from companies that aren’t aligned with ESG outcomes. Even the recent coronavirus crisis has sharpened our focus on sustainability issues.
In our view, the trend is only set to continue, and the direction of travel is clear: the investment portfolio of today needs to incorporate ESG considerations to deliver on its long-term goals.
Sources
[1] Nutmeg calculations using data from Macrobond for the period September 2007 to October 2018. Indices used are MSCI Mid & Large Cap Net Total Return. For more information: How do socially responsible portfolios perform
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 performance is 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