ESG is changing fast, only a few years back it was a novel concept now its big business, everybody everywhere is talking ESG.
I don’t think there is a single investment group that does not have ESG embedded into their process and many groups have ESG products covering a range of options. If ESG was a political movement, a movement that wanted to get the investment world to focus on environmental and social impacts then surely the job has been done.
I think about half the emails I receive now are on 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. As said, it if were a political movement the leaders could stand back, view the investment world and conclude their mission has been a success. Or has it?
As the ESG discussion has evolved it’s become ever more evident that nothing is black and white, there is no simple solution. When I say solution, I’m thinking in terms of solving environmental and social problems and how businesses are a critical part of that process. 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.
And as we focus on our impact the more granular we become, because each and every action we take as individuals has a consequence and through companies it multiplies to become major impacts for the planet. The reason we may wish to invest in a company or not invest may be driven by more 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 sustainability, ESG, values and concerns are.
I see the adoption of ESG having evolved so quickly that having it embedded into a process in no way confers on a 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 fundamental analysis. Analysts look at financial metrics, p/b, ebitda, free cash flow, the governance of a business and ESG should be an explicit part of that anaysis, if a group isn’t doing that now they are truly out of step.
Incorporating ESG in this way is no more than common sense, yet only a few years ago ESG integration set you aside from your peers, but 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 and the consequences of your process – what you are hoping to achieve in addition to a financial return?
Looking across the universe 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; perhaps that’s not surprising, after all the fund management industry is there to generate financial returns for clients from a universe of stocks, 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 prove to be a challenge but as investors become more informed about environmental and social issues the need to become more granular and to articulate your approach will become more pressing.
For me, an example of this can be found in the bottled water industry – In 2018, 50bn litres of bottled water was sold in the US and its estimated that the global market for bottled water by 2025 will be $215bn.
More bottled water is sold than Pepsi’s, Cokes and other fizzy drinks combined. On the one hand you could see this as a big achievement as people seem to be drinking more 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 loses its lustre. Bottled water uses 2000x more energy than the equivalent volume of tap water. Purified water takes 4 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’s by no mean complete. And we also know a huge amount of plastic ends up in our oceans – whilst we like the idea of recycling bottles, after all it seems obvious and there are companies out there using recycled plastics to make clothes, the truth of the matter is that in the UK only 10% of recycled bottled are made into bottles again.
Globally, only one fifth gets recycled, so 80% of plastic bottles water is sold in ends up somewhere else in the environment, often 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, so as an investor if I wanted to avoid companies involved in producing bottled water and their supply chains how would I do this? This highlights the complexity that focusing on single issues has, and by embracing ESG as more than a set of risks, a path the industry is embarking on, it does mean the industry has to broaden its thinking considerably.
See also: – Invest in the race to ditch plastic
The investment complexity we face with this and other issues is therefore not inconsiderable. Being clear about how a fund invests and how it considers things such as the bottled water industry is going to be increasingly important. A common language in the industry is going to be required to enable investors to understand how a fund approaches ESG/sustainability and these entwinned issues to ensure clients can line-up their own values and concerns with appropriate funds.
To-date much of the ESG approach has focused on the environment as this is more tangible from an investment perspective, 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, these would not necessarily lead an investment decision (but influence it) so for clients who wish to invest with gender and diversity as a priority there will need to be a means to provide analysis back to clients. And with the regulator likely to steer the advice piece in this direction, no doubt with a focus on sustainability (SFDR based), the direction of travel looks set.
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 another 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, there is unfortunately no neat overlay and addressing this is going to be a challenge, but a challenge that has to be faced.