Lowes Magazine Issue 120

DOUG’S DIGEST

The shape of things to come? overseas labour or misusing client data quickly brings their share price down. Which leaves the ‘E’, Environment, as the new kid on the block, (or letter in the acronym). A lot more focus has come in recent years on mankind’s affect on the world, both

IT SEEMS IMPOSSIBLE THESE DAYS TO SWITCH ON THE news without seeing stories covering climate change, environmental damage, or a scandal over companies mistreating their staff or customers. This has filtered through into the investment world, with it being rare to speak to an investment firm now without the subject of Environmental, Social, and Governance (ESG) investing coming up. ESG, as its name suggests, involves scoring and filtering companies based on three criteria when building a share portfolio, as described in the box below. There are several fund managers who we have met with many times over the years, who in recent meetings have been keen to explain how ESG is a core part of their analysis process and always has been, even though they have never mentioned it before. This is not a case of them being disingenuous, but merely now having a buzz phrase to cover something that a decent fund manager should have been considering all along. There are many criteria a company will be assessed on, but some examples are: Environment What impact does the company have? For example, is it taking steps to reduce its carbon footprint? Does it use toxic chemicals or damage the land in its manufacturing processes? Is its supply chain sustainable? Social This is both internal with employees, and external with customers, suppliers and the broader community. Are they taking steps to promote equality and diversity and eliminate discrimination? Do they have procedures in place, and does the whole company ethos promote social good and the well-being of people and society above the company’s profits? Governance How well is the company run? How engaged are the board Working backwards, the ‘G’, Governance, should always have been considered when investing in a business. No matter what industry it is in, or how good a product it has, if the business is not well run and has poor practices it will quickly lose ground on its competitors and lose would-be investors. The same goes for the ‘S’, Social. If the satisfaction and wellbeing of employees and customers are not at the heart of the company they will quickly become disillusioned and leave, causing a lowering of quality within the firm and a drop in income. Also, as we have seen in recent times, scandals about company’s using cheap and management in pushing through positive change? How is executive pay controlled and monitored? Do they promote diversity in leadership? Do they adopt best practices in accounting and reporting?

in terms of reducing our carbon footprint to limit the effects of climate change, and the physical damage we do and the long-term effects that has. Again, though, we just have to look at the impact the Deepwater Horizon oil spill had on BP to see that an astute investor would have had one eye on a company’s environmental impact long ago. One benefit of the arrival of ESG investing is that it has formalised and broadened the application of these criteria. For example, whilst institutional investors might have previously looked at accounting practices and the remuneration of the senior executives at a firm as part of their Governance review, they probably never thought to question the gender or ethnic diversity within the board and senior team. Now this is becoming commonplace and firms that are looking for external investors are having to consider these things seriously, which can only be a good thing. Proponents of ESG investing argue that the companies that score well tend to be better run, less prone to problems and unexpected bad news stories, and as such are the ones that will be better investments. This can be seen in the accompanying chart, which shows the performance of the MSCI World index and the MSCI World ESG Universal index, which aims to maintain the same broad and diversified universe as the mainstream index whilst enhancing the ESG exposure. As always though, it’s important to know exactly what it is you are investing in and why. The ESG index has outperformed slightly since its introduction, but this is likely down to two factors. First, the nature of the ESG scoring produces a bias towards the big technology companies which performed well last year during the pandemic induced lockdowns. Second, there is an element of clustering caused by the rise in popularity of ESG investing itself. As money moved into ESG funds, it meant that more was invested in the same high ESG scoring stocks, pushing their price up in the process. Our view is that ESG investing is here to stay, but it will eventually be integrated within the selection process of all investment funds, becoming a tool to help filter companies for inclusion within a portfolio. It will therefore be as necessary as ever to be sure we fully understand what the fund managers are doing within their fund to make sure it is suitable for inclusion within a portfolio.

ESG versus mainstream investing

80

70

MSCI World Return MSCI World ESG Universal Total Return

60

50

40

30

20

Percentage Growth

10

Source: FE Analytics. Bid-Bid. Net income reinvested.

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Lowes Financial Management is authorised and regulated by the Financial Conduct Authority. Visit: www.Lowes.co.uk | Call: 0191 281 8811 | Email: enquiry@Lowes.co.uk

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