ESG is changing, or so it seems to me. Only a few years back it was a novel concept, now it’s big business and everybody everywhere in the industry is talking about it. I don’t think there is a single investment group that does not have ESG embedded into their process and many investment groups have products covering a range of responsible investing options.
I think about half the emails I receive now are about ESG. Everyone wants to talk ESG, everyone wants to tell you how their process works, how they are different, how they engage and how they are making a difference. If ESG was a political movement the leaders could stand back, view the investment world and see that their mission has been accomplished. Or has it?
Evolution of ESG
As the discussion has evolved it’s become ever more evident that nothing is black and white. There is no simple solution to solving environmental and social problems. Once you start to focus on the impact a business has on the environment and society it’s possible to drill down to ever increasing depths – all companies have both positive and negative impacts and the scale of those varies considerably. But as we focus on our impact the more granular we have to become, because each and every action we take as individuals has an impact. Through companies it is multiplied. What’s more, the reason we may or may not wish to invest in a company could be driven by increasingly granular concerns.
It’s likely in the not-too-distant future the industry will need to engage much more with clients and ask what their environmental, social and governance values and concerns are. Historically this has been done at a high level and going back a few decades it simply centred around exclusions, such as no armaments, tobacco, alcohol etc, We all know the familiar pattern. But in many ways this approach, especially as a singular process, is archaic. I see the adoption of ESG having evolved so quickly that having it embedded into your process in no way confers on the fund an ESG quality. Indeed ESG has now reached the point where it should be in all investment processes as a matter of course, sitting alongside the fundamental analysis that the industry has done for years. Equity analysts look at metrics, p/b, EBITDA, free cash flow and the governance of business. ESG should form an explicit part of that, if a group isn’t doing that now they are truly out of step.
But incorporating ESG in this way is no more than common investment sense and this is one area where the industry has moved on because only a few years ago ESG integration set you aside from your peers – this is no longer the case. Indeed, if you wish to claim ESG credentials which are more than simple integrated risk metrics then you need to define the purpose of your fund, the consequences of your process and what you are hoping to achieve.
Looking across the landscape of ESG mandated funds there are plenty which have set their stall out with a purpose, but the approach and objectives of many funds is similar. That may not be surprising, after all the fund management industry is there to generate financial returns for clients from a universe of stocks and how you define that universe tends to be very similar to your competitors. However, it seems clear that the next stage of evolution is for funds with more clearly defined and specialist mandates. This might well prove to be a big challenge but as investors become more informed about environmental and social issues from an investment perspective the need to become more granular and to articulate your approach will become more pressing.
The plastic bottle paradox
For me an example of this can be found in the bottled water industry. In 2018, 50bn litres of bottled water were sold in the US and it’s estimated that the global market for bottled water by 2025 will be $215bn USD*. More bottled water is sold than Pepsi, Coke and other fizzy drinks combined*. On the one hand we can see this as a big achievement as people seem to be drinking more bottled water than sugary drinks, (a reason to invest perhaps?) however the scientific evidence for any health benefits of bottled water is virtually nil compared with tap water and amusingly in blind tastings tap water, including London’s, beat most mineral, spring and purified waters. Add to this the environmental impact of plastic bottles and the nature of the industry becomes clearer.
Bottled water uses 2000x more energy than the equivalent volume of tap water*. It takes four litres of water to produce a single litre of purified water and over 10 litres to make the plastic bottle*. Then of course there are the issues with the chemicals in the plastic; bisphenol (BPA) is a chemical that has been linked to low-birth-weight babies, cancers and has been banned in numerous countries*. Consequently, there has been a switch away from BPA plastic in bottles, although it is by no means complete. And we also know a huge amount of plastic ends up in our oceans. Unfortunately, it seems people like the idea of recycling bottles, after all it seems obvious and there are companies out there using recycled plastics to make clothes, but in the UK only 10% of recycled bottles are made into bottles again*. Globally only 1/5 gets recycled*, so 80% of plastic water bottles end up somewhere else in the environment, often it seems in the seas.
So, with no health benefits and tap water a fraction of the cost, plus the environmental damage caused by the industry, it’s hard to see a justification for bottled water. Yet it is a massive industry involving many companies, so as an investor if I wanted to avoid companies producing bottled water how would I do this? The point of this example is not to provide an answer, indeed I don’t have one, it’s to illustrate the complexity that focusing on issues has and this is a path the industry has embarked on, one which I think is very good, but it does mean the industry has to broaden out its thinking considerably. The investment complexity we face with this and many other issues are enormous - nothing is black and white.
Being clear about how a fund invests and how it considers things such as plastic bottles is going to be increasingly important and a common language in the industry is going to be required to enable investors to firstly understand how a fund approaches ESG/Sustainability and secondly these issues enabling clients to line-up their own values and concerns with appropriate funds. Much of the approach to-date has focused on the environment as this is more tangible especially from an investment opportunity point of view, but if companies are to operate with a genuine social licence and genuinely acknowledge their role in society then the industry will have to consider harder to quantify issues that will need to be expressed in client portfolios. An example is gender equality and diversity, neither of these may lead an investment decision but for clients who wish to invest in companies that lead in these areas then there will need to be a means of identifying them and providing analysis back to clients. I can see in time there will be a requirement to provide granular reporting to enable clients to select funds that truly match their own values. And with the regulator likely to drive the advice piece in this direction, probably with a focus on sustainability (SFDR based), the direction of travel is fairly well established.
In summary, ESG is evolving very quickly and for me it should be part and parcel of what fund managers do irrespective of whether they claim to have a purpose behind their ESG integration or not. At the moment, the industry provides fairly blunt tools for clients to build portfolios that align with their values and concerns and addressing this is going to be a huge challenge, but a challenge that has to be faced.
*Source – Spoon-Fed by Tim Spector. Jonathan Cape/Vintage Publications 2020.
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