Over the last month there have been two big news stories; Covid-19 and its fall out, and the dramatic fall in the price of oil. Seen together these significant events offer a fresh lens into a post-Covid-19 world.
Since mid-March, while socially isolated we have been subjected to a deluge of plague literature. We have all become YouTube epidemiologists, as noted by the recent Zapiro cartoon, The Experts. We know that historically pandemics tend to leave a major mark and that survivors (both from a health and financial point of view) emerge with different priorities.
The dramatic fall in the price of oil (currently $25.77) has yet to be expressed by petrol pumps prices, but oil futures have been in negative territory and oil tankers are currently sailing the world’s oceans with nowhere to deliver their loads.
So, where will we go from here? We know that the fall out of Covid-19 has placed moral hazard centre stage. We know that chaos creates opportunity. New ideas and products emerge and take hold. We know that in the past plagues have been catalysts for profound market shifts, resulting in wealth creation for some and destruction for others.
During the lockdown, the world has changed. Technophobes have taken to online shopping, Netflix and Zoom. Cannabis sales have rocketed! Beautiful pictures of clear skies on Instagram from Wuhan and Milan must be making the owners of carbon-heavy smokestack companies nervous. New working habits might be causing sleepless nights for motor car manufacturers and related industries, corporate landlords and companies that make or sell corporate clothing.
Increasingly, environmental, social and governance investing (ESG investing) is being framed as future-proofing a portfolio against future liability. Fund managers select companies expected to offer enduring value, where risk is fully priced and understood, as opposed to simply ‘feel good’ investing. Pro-ESG commentators point out that ESG investing could become standard as new priorities trigger a different allocation of capital.
After the trauma of WW2, there was a new interest in creating businesses and institutions to last. The interest in ‘long termism’ was core to the stability and wealth creation that lasted nearly fifty years. It is possible that a similar ‘long termism’ might also be Covid-19’s bequest.
In January this year, BlackRock, (the world’s largest asset manager with $7 trillion of assets under management), announced that concerning the company’s actively managed portfolios, it was planning to disinvest from companies that derived more than a quarter of their revenues from thermal coal, double the number of sustainability-focused exchange-traded funds it offered and to increase investment in sustainable assets 10-fold to $1 trillion within the next ten years.
According to a document published by KPMG earlier this year, Sustainable investing: Fast-forwarding its evolution, in the last decade various governments have enacted over 500 new measures to promote environmental, social and governance (ESG) investing. The same document describes ESG investing as ‘…not about jumping on the bandwagon, but about seeking to deliver financial and non-financial outcomes while managing the inherent risks’.
Long term investing is one of the cornerstones of ESG investing. In the pre-Covid-19 era, ESG investing was compulsory for many institutional investors but never became mainstream with retail investors with discretionary money for a range of reasons.
Attractive aspects of ESG investing
Carefully considered, ethical, ‘seat at the table’ long term investment decisions are the cornerstone of ESG fund managers. At best, long term investing also reduces investment risk and contributes to long term outperformance.
Demographic surveys show that millennials (those born between 1981 and 1996) express a keen interest in ESG investing. If ESG investing becomes mainstream, early adopters stand to gain.
Additional investment filters imposed by ESG requires fund managers to become familiar with many more data fields and in the process make more thorough investment decisions.
ESG investing strategies need regular consistently produced data on a wide range of topics to create investment screening strategies. For example, when investing in energy companies, data is required on carbon emissions, product carbon footprint, water stress, raw materials sourcing and disposal of waste. Not all these data fields are available in the public domain, and fund managers have to go the extra mile to do the necessary research. Over time, however, pressure from investors has encouraged companies to become more open.
Impact investing: As the ESG environment has matured, it has become clear that there is also a ‘scale of engagement’ amongst ESG fund managers. Early-stage ESG managers simply avoid harm by excluding red-flagged companies from portfolios while later stage investors seek active engagement with the companies they invest in, jointly seeking solutions and acting as agents of change.
Still a problem
There is a lack of clarity about the definition of ESG. The KPMG document quoted above notes that there are over 80 different terms used to describe different socially conscious investing principles. Some definitions include not only environmental, social and governance investing but ‘high impact’ investing, investments that benefit stakeholders and contribute to solving society’s problems. Some simply use negative screens, such as avoiding companies that sell or manufacture alcohol, tobacco or firearms, but conduct no other research.
Narrow choice of mandates: ESG investing has, up till now, been hampered by a limited range of products, investment styles and mandates. We were very pleased to hear about a new ESG fund with an absolute return mandate which addresses this gap.
Comparison of risk and performance: It is difficult to compare the ESG performance of different funds and investment vehicles. However, a financial advisor could help you with this.
Fake products: There are many ESG investment products which merely pay lip service to ESG.
Product vehicle choice
If you decide to invest according to an ESG fund you will still have many other decisions to make. Ask yourself the following questions:
- Should you invest in a unit trust fund that has an ESG mandate?
- Would it be cheaper to invest in a dedicated ESG exchange-traded fund?
- Might you get greater performance if you identified some up and coming eligible ESG companies and invested on a private equity basis? Or a basket of ESG firms using Section 12J of the Income Tax Act?
- What about choosing a fund that rewarded ESG leaders and shorted ESG laggards? Or a fund with a ‘decarbonisation strategy’ that bets against future losers?
The choices can be confusing. During the lockdown, we have been contacted by fund managers with ideas on where future opportunities may lie. If you would like to have a chat about any of the ideas mentioned in this article, please contact us.