The Big Exchange debates the question whether companies that aim to ‘do good’, do in fact make for a good investment.
February 2023
Investing in line with your principles is not new; the first ethical funds were launched in the UK in the mid-1980s for people who wanted to avoid activities considered harmful to society. So called vices like gambling and alcohol were excluded whilst companies demonstrating positive practices, such as good working conditions were favoured.
The rationale for such businesses also delivering decent returns was that responsible behaviour would attract more loyal customers and employees (brands such as Cadbury’s, M&S and Unilever thrived in part due to their paternalistic cultures).
A few years later saw the arrival of specialist environmental funds, led by Jupiter Ecology in 1988, aiming to get on board in the early days of the green revolution. Both approaches attracted a steady stream of investors, but it wasn’t until more recently that interest in putting your money to work for the good of people and planet has really started to gather momentum.
High profile campaigners like Sir David Attenborough and Greta Thunberg have certainly raised awareness of climate change and other environmental challenges. As a result, more of us are realising that how we live our lives and invest our money can make a difference. What’s more, we don’t necessarily have to choose between ‘principles or profits.’
Today we more commonly hear the term sustainable investing and, according to Morningstar, these strategies attracted £26bn of new money in 2022, whilst non-sustainable strategies (or strategies not labelled as sustainable) experienced significant outflows. [1]
Whilst most investors would say they take a responsible approach, in that they take account of ESG (Environmental, Social & Governance) issues that might reduce financial returns, sustainable investors also seek ESG opportunities in industries and companies that are set to benefit from the shift to a sustainable future.
Impact funds go a step further and focus on solutions to the world’s sustainability challenges which have a measurable positive impact alongside aiming for competitive financial returns. The Big Exchange offers several of these including a selection from UBAM and Triodos.
Sustainable investing is no longer a niche area, and it is now possible to build a diversified portfolio across geographies and asset classes. In addition to equity funds, there are others offering exposure, for example, to bonds, infrastructure, property. Investors can also opt for an ‘all in one multi-asset’ fund or even a thematic fund if interested in a specific industry, for example timber, water or clean energy.
As the number of funds has grown to meet demand, so too has the investment universe. The opportunity set of companies is constantly evolving too as technology advances. Wind and solar energy were still at the developmental stage when the first environmental funds were launched but is now fast replacing fossil fuels for power generation.
Current innovations include energy storage solutions to tackle the intermittency problem (sometimes the sun doesn’t shine, or the wind doesn’t blow) and ‘green’ hydrogen (generated using renewable electricity) to de-carbonise heavy polluting industries such as cement or shipping.
Companies driving positive change can be found in a wide range of industries, with products and service encompassing clean energy, electrification of transport, healthy and sustainable food, lifesaving treatments, healthcare for a better quality of life, and improved access to education and financial services.
Emerging megatrends include the more widespread adoption of a circular economy business model. This involves recycling and reuse of raw materials and goods which can reduce the need to keep extracting finite natural resources.
Biodiversity is another area garnering attention; we need to make good the damage mankind has done. Industries that are playing a part in biodiversity restoration include precision agriculture and alternative proteins (such as plant-based foods).
Technology is key to the development of industries that didn’t exist a few years ago. Many tech companies are enablers of the innovative products helping to advance progress towards the SDGs (Sustainable Development Goals). For example, semi-conductors are critical components in a huge number of applications from communications to healthcare and transport.
The pandemic highlighted inequalities in society and the need to ‘do the right thing’. This means considering the social needs of all parties affected by their activities and supporting them by way of high employee welfare standards, product quality and safety, efficient use of natural resources, and support for local communities.
The race to find an effective vaccine against Covid is an example of what can be achieved when businesses and governments work together (in this case by providing expertise and fast track approval). Short-term costs could bring long-term benefits in terms of customer and brand loyalty, attracting and retaining staff, and raising capital for future development. All of which could translate into higher profits and shareholder returns.
Many sustainable funds will exclude (or set revenue thresholds for) ‘the bad stuff’, meaning harmful activities such as fossil fuel extraction, tobacco and military whilst also avoiding companies with high carbon footprints and poor scores for water and energy consumption.
Examples of funds with an emphasis on ‘social’ or ‘people’ factors include CT UK Social Bond, Schroder Global Healthcare and abrdn UK Ethical Equity. It is important to us to highlight these factors and we created filters on The Big Exchange so that people can look at the fund list from a social angle as well as environmental.
Policies to tackle climate change and protect the environment are commonplace with most major countries introducing some form of green subsidies. Many governments’ post Covid recovery policies have a significant allocation to green spending. Sustainable investing is expected to see a considerable boost from the US Inflation Reduction Act and the EU Green Plan.
Government support for de-carbonisation (as well as consumer demand) has resulted in the availability of clean, cost-competitive renewable energy and a big increase in market share for electric vehicles. Meanwhile, companies on the wrong side of regulations are likely to face fines and reputational damage.
Although not guaranteed, all the trends mentioned look promising for longer-term investment returns, but 2022 proved a difficult year for the growth style of investing as the war in Ukraine (and sanctions on Russian oil and gas) plunged much of the developed world into an energy crisis.
A spike in the price of fossil fuels was a money spinner for traditional energy companies which were the standout stock market performers. Interest rate increases to combat inflation proved another headwind for high growth companies, as it affects the way they are valued.
Nevertheless, we see this as a setback on the path to a sustainability future not a change of direction. Prices of oil and gas are today well below their peak and if anything, recent events have heightened the importance of ensuring energy security.
As the focus is on growth, sustainable investing should be embraced for the longer term and is not the way to make a fast buck. Also, it is important to combine traditional financial analysis with a holistic view of a company. Ticking the green/social boxes alone will not necessarily produce positive financial returns.
However, we believe that companies addressing environmental and social challenges will experience high demand for their products and services which may lead to bigger profits and returns for shareholders. Another way sustainable strategies aim to add value is by engaging with companies and pushing them to improve their operating performance.
So, in our opinion doing good doesn’t mean sacrificing returns. Of course, all investing carries risks and there will be winners and losers in every field, but active fund managers apply their skills to try and find those long-term winners.
Indeed, despite two difficult years in 2021 and 2022, when the value style of investing (think oil and gas, mining, tobacco and financial stocks) returned to favour, longer-term returns are still healthy. The MSCI ACWI (All Country World Index) ESG Leaders index is up 53.3% over 5 years (to 31 Jan 2023), compared with 51.2% for the MSCI ACWI index. [2]
This is just one example that shows that you don’t necessarily need to compromise on returns when you invest for people and planet.
To help consumers find the products that match their needs (and clamp down on greenwashing) the FCA (Financial Conduct Authority) is planning to introduce Sustainable Disclosure Requirements (SDR), which will allow funds to adopt labels which relate to their suitability objectives and strategy.
We broadly support the proposals and you can see our response to the FCA published here.
At the Big Exchange we use our own impact methodology to rate funds for the level of positive impact they are having and award them gold, silver or bronze medals. Those that don’t make the grade don’t qualify for listing with us.
In summary, we believe that the way we invest can play a role in ensuring a sustainable future for future generations. What’s more, there are an increasing number of attractive investment opportunities. Companies seeking to address social and environmental challenges generally benefit from strong demand for their products and services which can lead to healthy profits and shareholder returns.
If you have more questions about investing you can visit The Big Exchange website and download one of our free guides or even send us a message to see if we can help direct you to the answers you need.
[1] https://www.morningstar.co.uk/uk/news/231339/2022-biggest-fund-outflows-in-a-decade.aspx
[2] FE Analytics January 31, 2023, total returns in GB sterling
Please remember that when investing, making money is not guaranteed and your capital is at risk. The value of your fund can go down as well as up. Tax treatment depends on an individual’s circumstances and may be subject to change.
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