The big bucks bonanza in Corporate Karma
Global asset managers have elevated environmental, social and governance (ESG) considerations into the mainstream of their investment selection and portfolio construction activities. In fact, ESG has become so integrated into asset management methodologies that Katherine Davidson, Portfolio Manager and Sustainability Specialist at Schroders, reckons it will hardly warrant a mention a decade from today. Davidson used a panel discussion at the 2021 Allan Gray Investment Summit to introduce the concept of “Corporate Karma” and share some of the investment themes arising from it.
Consumers lead sustainable investment megatrend
It may seem as if the industry’s focus on ESG, impact and sustainable investing came about overnight; but in reality these themes have been incubating for some time, driven initially by governments and regulators and more recently by growing pressure from consumers to ‘invest green’. “Our clients, based on both the institutional and retail experience, are showing increasing enthusiasm for sustainable investments [and greater concern] for the impact their investments have on the wider world,” said Davidson. As a result, assets under management in the ESG equity space have grown to around US$2 trillion in recent years.
The Covid-19 pandemic has become a catalyst for stakeholders in the asset management industry to expand their thinking about ESG. A survey of Schroders’ institutional clients, accounting for some US$27 trillion in assets under management, showed near total agreement that “Covid-19 has raised the profile of ESG within their investing activities or within their organisations”. At the same time, more than 80% of retail investors have indicated a greater desire to align their personal values with the values applied to their invested capital. “Retail investors want to invest in a way that meets their personal and ethical principles,” said Davidson.
Asset managers drive continuous ESG improvements
Asset managers have started restructuring their businesses to accommodate this shift in sentiment. Schroders, which has considered sustainability factors in investing for more than two decades, already has more than 22 permanent staff who focus on this construct. These staff perform a range of functions including the identification and measurement of ESG factors across the investible universe and ongoing engagement with management teams at various firms to ensure continuous ESG improvements.
The most common objection that asset managers encountered on their ESG investing journeys was that a greater focus on sustainability would result in lower investment returns. It has since emerged that the opposite is true. According to Davidson, there is a kind of Corporate Karma that stems from how a company interacts with the environment and society… For ESG-focused firms, this karma exhibits as higher rather than lower returns to stakeholders. “We are all trying to invest in companies that will deliver supernormal growth returns over a long term investment horizon; in order to do that, you need to look out for your wider stakeholders,” she said.
There are countless examples of how a firms’ focus on ESG drives higher returns. An obvious starting point is a company’s relationship with employees. Companies can generate short term returns by spending less on employee benefits and wages; but over the long term such strategies result in poor employee loyalty, high staff turnover and an inability to attract and retain top talent, among other negatives. The bottom line is that “dynamic companies that are run with a stakeholder-centric view produce superior operating performances over time”. A firm’s consideration for employees is thus something that asset managers keep a close watch on. And it makes sense for your company to build this outlook into its culture too!
Valuable lessons about investment timeframes
ESG factors and other sustainability considerations can teach asset managers valuable lessons about investment timeframes. Davidson said that too many asset managers were focusing on quarterly earnings and sales reports, with limited focus on the value creation potential over periods exceeding five years. “We can exploit that market inefficiency by thinking longer term and looking at the stakeholder relationships in the corporate culture that underpins a company’s ability to grow and compound over that timeframe,” she said. A big part of the alpha generated by Schroders comes courtesy owning companies for periods exceeding five years.
How should asset managers go about identifying investment opportunities as sustainability becomes more mainstream? One tip is to expand your research beyond the obvious sources of information. Most of the analyst presentations we have attended in the past year or two have mentioned that third party ESG ratings can be inconsistent, with too many biases built into the various scoring methodologies. Schroders is addressing this issue by building up ESG and sustainability research capacity inhouse: “The more ESG becomes embedded in your investment process; the more risky it becomes to outsource,” noted Davidson.
US-based electric vehicle (EV) manufacture, Tesla, offers great insights into the complexities of ESG and sustainability ratings. “Tesla really divides the sustainability ratings agencies; we see the share in the top quartile for one and in bottom quarter for another,” said Davidson. Complexity and subjectivity creeps in around trade-offs between the manufacture and usage of product; the sourcing and processing of input materials; and labour, among a range of other issues. Albert Einstein summarised the challenge perfectly when he said: “that not everything that counts can be counted, and not everything that can be counted counts”.
Safaricom: Focus on the transformative impact
The Schroders Global Sustainable Growth fund has a multi-year track record in seeking out sustainably run companies that reward investors with long term returns. An example shared during the 2021 AGIS was Kenya-based telecommunications company, Safaricom. This company “exemplifies a lot of factors we look for from our holdings,” said Davidson. “It demonstrates that you can do good for society and for your stakeholders without diminishing the return to your shareholders”.
Safaricom was among the first companies that attempted to measure the transformative impact of its business activities on the economy, having commissioned KPMG to do an annual assessment. These assessments showed up to 10 times annual profits flowing to society in positive externalities. Asset managers are responding to investors’ demands for ESG-focused funds by developing tools that allow them to measure the negative and positive externalities of the companies they invest in. “We are able to report the impact of our investments alongside the risk and reward … and aim to deliver consistent outperformance without causing harm to society or the environment,” concluded Davidson.
Writer’s thoughts:
The more ESG, impact and sustainability presentations I attend, the more I am convinced that the long term investing and sustainability concepts are inextricably interwoven. I mean, how can one commit to a company for the long term if that company is not run on a sustainable basis? Are you surprised that the sustainability concept does not feature more prominently in the financial planning environment? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected]
