Facebook CEO Mark Zuckerberg faced some tough (and awkward) questions when grilled by the US Congress last week.
The social media platform has faced significant criticism about its efforts to protect the privacy of users, after it emerged that the election consultancy Cambridge Analytica used the data of millions of users without their consent and potentially influenced voter behaviour in the process.
Even though Facebook’s share price took a beating in the wake of the scandal, the company has still delivered a 16.55% return over a one-year period, according to Bloomberg. Long-term investors in particular have been handsomely rewarded.
While investors tend to pay lip-service to environmental, social and governance (ESG) factors at the firms they invest in as long as returns are favourable, recent corporate scandals at Steinhoff and Tiger Brands have highlighted how serious the damage can be when safeguards fail.
Research conducted by Bank of America Merrill Lynch shows that companies that are well-run from an ESG perspective, typically have much lower drawdowns than companies that are not.
Alex Tedder, head of global equities at UK-based asset manager Schroders, says it seems obvious that a well-run business would pay attention to ESG factors, but it is not the way a lot of companies or investors think yet.
“I think they will do, but it is [at a] very early stage. In the United States for example ESG is not really a factor right now. A lot of the investors don’t really look at it.”
Facebook, which has an absolute weight of 2.3% in its Global Equity Alpha Fund, is a great company that has delivered fantastic returns for investors, Tedder says.
“It offers a great growth profile [and] has a very strong franchise, but it is a company that actually has slightly problematic relationships with some of its stakeholders,” he adds.
Some of the key issues are how much responsibility a social network should have given that it is basically ungoverned, yet actively part of more than a billion people’s lives. There are also questions about Facebook’s political influence, whether it should be regulated and if certain individuals should not be allowed to use it.
While it explicitly scores ESG factors for the companies it invests in, Tedder says historically these factors have been underestimated by most people.
“Now I think people are aware that it has a direct impact on a range of stakeholders but ultimately on you as a shareholder.”
The difficulty for investors is that it is very hard to know which companies have dubious compliance processes until there is an event that demonstrates it, he adds.
“Quite a lot of it is ex-post. You suddenly realise this is not what I thought.”
While Tedder concedes that Facebook is a high-risk stock, it also has “fabulous metrics”.
“From a financial standpoint and a return standpoint it has been a brilliant investment and that is what we do – we balance the risk and return.”
However, the risks – particularly with regard to social and regulatory issues – seem to be weighing on sentiment.
“We are becoming less confident about the holding because we think that the risk of regulation is rising very rapidly.”
While ESG considerations won’t protect investors against a meltdown such as Steinhoff – particularly if there was fraud involved – it can assist in limiting the damage when an unfortunate event occurs by restricting allocations to the stock. It may also offer an opportunity for fund managers to lobby management to improve their practices.
Tedder says ESG considerations can’t protect investors against corporate failures such as Steinhoff as these events are very difficult to predict.
“If a manager is lying, it is very difficult to assess that and you’ll always have situations that you get wrong – every investor has that, but our view is simply that you have got to be systematic about it… It [ESG considerations] has to be integrated into your process and there has to be a trade-off between risk and return.”
Where a company scores very negatively on one aspect of environmental, social or governance considerations, it will influence their decision to invest, Tedder says.
“Either it will be a smaller position or there will be no position at all. Facebook is a reasonably-sized position in the portfolio. Google has a much bigger position in the portfolio because in the case of Google we actually see less risk than we do with Facebook.”