Al Gore once said: “Improving the quality of life without borrowing from the future is the single largest investment opportunity in history.” Where investing with a conscience historically involved screening out companies deemed to harm the planet or its inhabitants, trustees are increasingly looking for positive attributes. We think this is a good thing – not just for the planet but also potentially for investment returns too.
Negative screening has strong merits, which is why we and many of our peers run mandates for clients using this approach. It is easy to explain to investors, for instance, that you are excluding tobacco, oil, munitions and mining stocks. Often this will suffice to keep everyone happy, but it does not take too much interrogation of your investment policy to realise that negative screening is not as simple as it may sound. You might rule out BP and Imperial Tobacco, for instance, but should you also exclude Tesco, which derives a proportion of its profits from the sale of petrol and cigarettes? Do you look at the sources of profit in secondary companies and determine a tipping point at which revenue from excluded industries makes them unacceptable?
Another problem with this approach is that it is a relatively crude way of addressing what many consider to be the greatest issues of our age – the environment and climate change.
Protecting the planet
The evidence documenting the impact modern society is having on the planet is undeniable. The last three decades have been hotter than any previous decade; the rate at which mean sea levels are rising has increased from 3mm per year between 1997 and 2006 to 4mm per year between 2007 and 2016; and global plastic production is expected to triple by 2050, by which point there will be more plastic than fish in our oceans. The problems we face are not only accelerating: they are reaching crisis levels.
From documentaries like An Inconvenient Truth, Cowspiracy and Sir David Attenborough’s Blue Planet, through to the protests inspired by Swedish teenager Greta Thunberg, concerns about climate change are moving from the fringes of politics to the core. And that means these issues matter to charity supporters, too. Organisations are increasingly likely to be asked questions about how they are investing their money.
Recent developments in the way companies report their global impact and the growing availability of quality research have enhanced our ability to invest in a more positive and thoughtful way. Importantly, they allow us to incorporate a much more sophisticated assessment of the environmental impact of all companies within the investment process.
Rather than negatively screening businesses, we can positively screen them. We can pick out those that are doing the most to benefit society.
One area where this is easily apparent is consumer goods companies. These are under mounting pressure to ensure that the source of the raw materials they use is sustainable, that packaging is recyclable and that products are not polluting – all while trying to reduce their own carbon footprints. Their customers want to continue washing their clothes and cleaning their teeth – but in the knowledge that it is not costing the Earth.
A good example of an outstanding company in this sphere is Unilever, which was an early mover in addressing the sustainability conundrum and has an ambitious target of becoming carbon neutral by 2030. In September this year, it announced that it had reached 100 per cent renewable energy use across five continents.
Another company, Mondelez – the global leader in the snacking category and owner of Cadbury’s – has launched its Cocoa Life programme. It is working to improve the sourcing of its cocoa beans and to tackle child labour practices. Through education and technology, it is augmenting cocoa yields and reducing land use. It has also targeted 100 per cent recyclable packaging by 2025.
Not so sinful stocks?
Investing positively may even encourage investors to address areas they would hitherto have screened out. The mining industry is a good example. It is often labelled a sin sector because of its environmental impact. We do not disagree, but the extraction of minerals is also at the centre of human advancement.
Iron ore, for example, is a fundamental building block of a modern society. As GDP per capita rises and nations get richer, there is a direct correlation with the installed base of steel – of which iron ore is the fundamental ingredient.
According to research company Bernstein, the stock of steel in the global economy is 32 billion tonnes today, representing four tonnes per person. But this is unevenly distributed, with 15 tonnes per person in the West and only one tonne per person in Africa and 6.5 in China. To bring the world up to 15 tonnes per person would require a 240 per cent increase in the global stock of steel. Growth in demand for steel remains directly linked to human economic progress, and to deny emerging nations the opportunity to modernise is to perpetuate the problems of poverty and global inequality that many charities are trying to overcome.
The extraction of copper is similarly problematic. One of the great industrial revolutions of our time will be the electrification of vehicles and the demise of the internal combustion engine (ICE). Today, transport accounts for 24 per cent of energy-related carbon dioxide emissions globally, so replacing the ICE will be a significant step forward in addressing climate change. Copper is one of the key components that will facilitate this change within electric vehicles as well as within the renewable power generation assets and electricity transmission networks that will replace carbon-emitting fossil fuels. Only then can electric vehicles truly claim to be green.
How does a charity address an environmental conundrum like this? The answer can lie in positive screening – picking the copper-mining companies that are operating to the highest standards.
A firm like Rio Tinto derives the majority of its profits from the extraction and sale of both iron ore and copper. Rio’s pedigree is impressive: it is a rare member of the FTSE 100 survivors’ list, having been part of the index since its inception in 1984. In that time, Rio has been the fourth-best performer, delivering an annualised total return of 12 per cent.
Its iron ore operations are of the highest quality, meaning they require less energy for extraction and smelting. High standards of corporate governance have led to sensible strategic decisions. The company has sold its coal assets and has resisted the temptation to chase growth in regions where corruption and labour practices have seen others stumble.
Governance and social considerations
Strong corporate governance practices are the foundation on which sustainable environmental policies are built. With independent board members and greater levels of diversity in terms of sex and ethnicity, as well as protections in place for shareholders (owners), strong corporate governance should ensure that companies allocate capital for the longer term in a sustainable manner.
Similarly, we should consider how a company treats its employees, suppliers, customers and neighbours. These make up the social in ESG (environmental, social, governance). Analysis of share price performance has found that companies with high employee satisfaction ratings significantly outperform those with low ratings. There are similar benefits in building healthy, fair relationships with other stakeholders.
The good news is that embracing this approach to investing can enhance returns. We believe companies that allocate capital responsibly, putting ESG considerations at the centre of their strategic frameworks, are more likely to succeed in the longer term than those that do not. With comprehensive analytics at our disposal, we can hold businesses to account and identify risks that might hold back attractive long-term returns in the future.
Once we have chosen to invest, we engage with management teams on a regular basis. We make full use of our powers to vote at AGMs on issues that might concern us and use a proxy consultant to help ensure we make the most of this valuable way of ensuring the companies we invest in operate ever more sustainably.
Of course, investment managers still need to pay heed to the increasing premium emerging in the prices of stocks identified as ESG champions. Goldman Sachs has found that the companies most often held in ESG-focused funds have on average a 40 per cent valuation premium relative to other companies. While we are strong believers in the persistency of the trends discussed in this report, we must be diligent in making sure that the price we pay is justified by the likely return.
Questions to consider
What does this mean to charity trustees looking for a wealth manager? Certainly, you should choose a manager that factors ESG into its investment process and can manifestly prove it. You should consider if you need a bespoke approach that is tailored to the interests of your particular charity and its supporters. If so, then you should seek out a manager that can help you establish a clear mandate that works well for you and stands up to the rigours of external interrogation. It is worth examining whether a manager can list every component of your portfolio and justify its inclusion against your agreed mandate. You may also want to ask for assistance in communicating the investment strategy effectively to supporters, because, as we have shown, the dilemmas can be more complex than people might expect.
Finally, you should choose a manager with strong investment performance net of all charges. There is little point in seeking to do good with your financial reserves if you do not maximise the universe of opportunities and undermine your charity’s ability to meet its primary objectives.
Nicola Barber is head of charities at James Hambro & Partners
Charity Finance wishes to thank James Hambro for its support with this article