awksmoor Investment Management did one of its country roadshows last month, where it told its investment advisers and clients that its focus this year was on investing in sustainable portfolios. It was not alone. Environmental, Social and Governance, or ESG, issues are rapidly becoming mainstream, be they the concerns of a small fund manager like Hawksmoor or the biggest like BlackRock.
Indeed the Global Sustainable Investment Alliance reported that in 2018 global investment products linked to ESG were worth $31 trillion, and industry projections are that they will top $40 trillion this year. Be that as it may, Hawksmoor looks for investments which aim to make a positive impact on the environment and society. It looks for investments which embrace the best practices and avoids the sin stocks like gambling, tobacco and armaments.
All good stuff but the 2020 version of the Credit Suisse Global Investment Returns Year Book, written as usual by Professors Elroy Dimson, Paul Marsh and Mike Staunton, decided to look closely at what ESG actually does. Does it have its own reward in terms of high returns for lower risk? Do investors sacrifice returns as the price for their principles? Do we actually know what ESG is? The final point is fairly fundamental because some of the biggest index providers and rating agencies don’t always agree.
For example, Tesla is, according to MSCI, ranked at the top for sustainability. But FTSE ranks it as the worst global cars producer. A third, Sustainalytics, says it is in the middle. The difference is that MSCI focuses on the car and its lack of emissions while the FTSE looks at the factories and what goes into the batteries. Nor is it just Tesla. According to the Year Book, Facebook gets a very low ranking for environmental issues by Sustainalytics, whereas MSCI ranks it highly. On the social pillar the rankings are reversed.
MSCI rates Facebook as good whereas Sustainalytics places it among the bad. MSCI ranks three companies, JPMorgan Chase, Wells Fargo and Pfizer as being extremely poor on governance but Sustainalytics rates them as very high.
MSCI says Walmart is good on social, but FTSE says it is terrible. Johnson & Johnson is good or bad on governance depending on whether one asks MSCI or Sustainalytics. Even the overall ratings where Environmental, Social and Governance scores are combined don’t help. For example MSCI ranks Wells Fargo as poor (12th percentile) for ESG, while FTSE ranks it highly (94th percentile). It is not that any of the organisations are wrong as such, but they do look at different data.
Then there is the problem of weightings. In the insurance industry for example, Sustainalytics places roughly similar weights on all three ESG components. In contrast MSCI places a 5% weight on environmental; 74% on social and 21% on governance.
All this makes the benchmarks “interesting”, so anyone looking to invest in a fund should find out what it contains. Also have a look at its back history before it was launched, because this always shows significant outperformance, followed, when it is launched, by underperformance or at best only tracking the wider market. Find out, too, whether or not the global benchmark includes the United States because it is quite different from Europe.
Now on to the second part of the authors’ question: are actions to boost ESG, or Corporate Social Responsibility (more or less the same thing) rewarded by appreciation in the share price? Or does it involve sacrifice? Basically no, on the share price, the authors say, having studied the research and data from scores of academics. There is one-off appreciation to positive changes in governance as investors adjust but after that, the “G” of ESG is in the price.
Shares responded positively to E and S changes, but again over time the effect becomes muted. After all, companies have to invest significant sums, which may not be a plus in share price terms. The overall implication is that ESG ratings may now be fully reflected in stock prices. The same is true if you exclude sin stocks from your portfolio. There may be a slight underperformance, though this is ambiguous, and even if it is, it is hardly material.
All this does not stop Hawksmoor or anyone else buying into such a fund. Indeed it is probably a good idea. But some ESG metrics are better that others. So be careful what you ask for, in case you get it.