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Point of View

Investing for a better world

Duncan Burden, Senior Equity Analyst

Across Europe, assets under management in socially responsible investment (SRI) funds have accelerated to reach trillions of euros, and the millennial generation is leading the way by investing in companies which have a positive social impact.
 
While SRI may still be considered a niche market, it is entirely possible that in 15 to 20 years it will have become the new mainstream, eclipsing funds which invest in ‘vice’ sectors, such as armaments and tobacco.

SRI covers a range of investment strategies, but the biggest, and best understood, simply restricts investment in certain funds or equities, such as tobacco or weapons manufacture. According to the Eurosif European SRI Study 2016, this approach has grown rapidly to reach more than €10 trillion in assets under management.
 
But another option, which is helping to fuel the rapid growth in this kind of investing, is a strategy with the less than snappy title of environmental, social and governance (ESG) integration. It sees asset managers include ESG factors in their financial analysis and has also grown quickly to €2 trillion under management – and I believe it will continue to gather pace.
 
ESG scores are based on factors such as how a business deals with environmental concerns and how well it treats its employees. It also looks at a company’s governance board structure, its composition and diversity. Explicit consideration is given to all these factors before an investment is made.
 
I believe the growth in the SRI sector is being driven partly by consumer preference. Among millennials – broadly defined as those born between the early 1980s and 2000 – there is a real sense that adjusting consumption and spending patterns can have a profound impact on important environmental and social issues. For example, the 250%* rise in veganism since 2006 has been led by this group and they have a similar belief in their ability to have a positive impact when it comes to investing. Millennials are four times more likely to be involved in socially responsible investing than those in Generation X (born in the 1960s and 1970s).
 
Some of the world’s biggest funds are also helping to encourage the trend of socially responsible investing. The world’s asset owners, such as pension and sovereign wealth funds, are tightening up their requirements for ESG integration. For a fund manager to be in the game for big institutional money, consideration of ESG factors is a bare minimum.

Change from within

Investors may decide they only want to put money into organisations with high ESG scores. However, by avoiding investment in so-called vice stocks – gambling, tobacco and arms – could they be missing the opportunity to use their power as shareholders to force change from within?
 
If you have 1,000 criminals and 1,000 kind people, what’s the best use of your time and efforts? Do you make the kind a little kinder or do you try and reform the criminals? The most popular choice would be to make the bad good.
 
Theoretically, by investing money in ‘bad’ companies and advocating change through shareholder resolutions and proposals via proxy voting, it should be possible to encourage better social and environmental behaviours.
 
But in practice he accepts this does have its limits. You can’t walk into a tobacco firm’s boardroom and tell them to stop selling cigarettes. They would laugh you out of the room. You’d also feel pretty uncomfortable taking a dividend from them. It wouldn’t be acceptable to a socially responsible investor.

However, companies with lower ESG scores may struggle to raise new capital from investors and see their share prices fall. In contrast, those with higher ESG scores can theoretically expect to find it easier to raise capital and their share prices could be higher.

Making returns

Some observers have asked whether socially responsible investors can make a positive financial return out of their investments – or if the motivation is purely to do with altruism and striving to make a better world.

There is a long-held myth that ethical investing impairs your returns. Certainly for charity donations you wouldn’t expect to get anything back, but with SRI you can feel positive that you are investing for the greater good and potentially enjoy healthy returns.
 
If you engage and invest early in a company whose ESG score is likely to improve, and assuming that the ESG factor has a material impact on the company’s financials, that company has the potential to provide attractive returns. It very much depends on deeper research, however, because an ESG score can’t be considered a replacement for traditional analysis. But you should look for firms that have SRI as part of their strategy and whose ESG scores are improving.”
 
Choosing to invest in enterprises and projects with new technologies and techniques aimed at protecting the environment or improving social issues is sometimes called Impact Investing. One example of this is green or social impact bonds, which are issued to investors by the public sector. Here, the level of return to investors depends on specified social improvements being achieved.
 
There has been a change in the attitude of social investors. They want to see measurable social and financial returns. The scope and materiality of a company’s social impact is more important than it ever has been. We are seeing a new wave of social investors take the front seat and a proliferation of products to meet their longer-term financial goals as well as reflect their current overarching societal values. It is a newer option for young philanthropists and here at Sanlam we are excited about opening it out to them.

Looking ahead

So, how will the SRI sector evolve? I see a continued shift in focus towards the chronic issues of our time that are highlighted by the United Nations 17 sustainable development goals, which set a long-term agenda for governments, companies and investors to drive material change in social issues over the coming decades. There is currently too much short-term thinking in governments and businesses. This needs to change if we are to effectively tackle chronic issues, rather than focusing on short termism.
 
We’ll also see more advocacy from investors. We are already seeing some activist hedge funds using Greenpeace-type tactics of flying helicopters over diamond mines to ensure fair treatment of workers, but we don’t need to go anywhere near that far to drive positive change.
 
We recently saw State Street Global Advisors (the world’s third largest asset manager) installing a bronze statue of a defiant girl staring down the iconic bull of Wall Street statue to highlight the need for gender diversity. It was accompanied by a statement saying it would vote against boards not taking sufficient steps to improve gender diversity in the boardroom. And we are seeing groups such as Legal & General threaten to vote against companies that are not improving their environmental policy. We will see more and more of this.
 
Many are concerned that with the resurgence in far-right populism, we run the risk of undoing social and environmental progress made over the years. Short-term setbacks may very well occur along the way, but we simply won’t see a permanent reversal in social progress. The combined power of more progressive governments, asset owners and consumers is more than enough to create huge opportunity for entrepreneurs and investors seeking to make a social impact.

Find out more

To find out more or discuss socially responsible investing, please email Duncan.
 
*The Guardian, 27 May 2016

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.