Investors need to appreciate what responsible investing can bring to their portfolio and stop treating it as a fad, according to Troy Asset Management’s Hugo Ure, who said that it has become an essential part of the firm’s research.
Ethical fund assets under management rose to £16.8bn in February, according to the latest figures available from the Investment Association, its highest level since September – although this remains just 1.4 per cent of the industry total.
Source: FE Analytics
However, there has been a much greater focus on funds that take socially responsible investment criteria into consideration in recent years as investors seek to align their portfolios with their beliefs.
Ure, head of responsible investment at Troy, said environmental, social & governance (ESG) issues are as important as any other metric that the firm looks at.
He said: “It appears odd to us that one would differentiate between the financial sustainability of an investment and its sustainability from an environmental, social or governance perspective.
“It seems elementary that investors should aim to understand all the material risk of an investment, regardless of whether they relate to gearing or greenhouse gases, compounded growth or corruption, disintermediation or disenfranchisement.
“Only then should investors consider the potential upside.”
The marriage of ESG criteria with traditional investment processes can be beneficial for investors, said the fund manager.
Ure – who manages the Trojan Ethical Income fund – highlighted studies by Oxford and Hamburg universities showing that prudent sustainability practices have a positive influence on performance.
The manager said this is something that the firm has put into practice by avoiding sectors with unfavourable non-financial risks.
“The mining sector represents a good example,” he explained. “Here environmental remediation costs are commonplace as are the social and governance risks associated with operating in developing economies.
“These are layered on top of cyclicality and capital intensity to create a blend of risks to your capital that we would rather avoid.”
Ure added: “There has long been a debate about whether such an emphasis on non-financial factors adds value. We have little doubt in our minds that not only is there a positive impact but more importantly that this impact is growing.”
The Troy manager said that if analysis of non-financial factors helps to avoid stock-specific risks then there can be a material return from such research.
One such example was the failure of the tailings dam – used to store by-products of mining operations – at Brumadinho in Brazil earlier this year, he said.
Performance of the stock YTD
Source: Nasdaq
Ure said the failure of the dam – Brazil’s worst labour catastrophe on record – followed a downgrade of Vale by many ESG research providers, such as MSCI and ISS Ethix.
“Although our process is not beholden to such changes in ratings, investors who heeded these concerns may have avoided the 25 per cent share price fall that followed the recent disaster,” he explained.
As investors become increasingly aware of ESG issues, said Ure, companies that fall below the required standards are likely to see discount rates applied to their earnings impacting the value – most likely through share price.
This trend has already been seen in the fixed income space, the Trojan Ethical Income manager noted.
“A particularly powerful indicator of this trend is the move by the credit rating agencies towards the integration of ESG factors into their analysis,” he said. “As this process gains traction, poor sustainability will result in a higher cost of debt for issuers that fall short of good practice.”
However, there will be occasions where companies that screen well on ESG and traditional criteria do not necessarily fit with investors’ morals.
“Europe’s alcoholic beverage manufacturers are a very strong case in point,” he said. “Diageo has delivered nearly four times the return of the FTSE All Share and an unbroken track record of dividend growth.”
Ure added: “Although it is hard to argue that such companies have not proved sustainable over the long term, many investors feel unable to invest in such stocks based on deeply held principles or beliefs.”
As such, investors who wish to take more of an ethical stance with their portfolio will need to stipulate any additional criteria, said Ure.
The Trojan Ethical Income fund – which targets a growing yield with lower than average volatility –passed its third anniversary in January. The fund, said Ure, is rare in utilising a negative screen while offering a meaningful yield, which has grown in each of the three years since launch.
The ethical screen excludes many of the traditionally highest-yielding sectors such as tobacco, alcohol and oil & gas, where its criteria restricts exposure. It does have greater flexibility to invest up to 30 per cent of the portfolio overseas allowing the traditional sources of income to be replaced.
Yet, this comes at the expense of sitting within the IA Unclassified sector, unlike its sister fund Trojan Income which resides within the IA UK Equity Income where overseas exposure is capped at 20 per cent.
The fund’s largest holdings include consumer goods company Unilever, which represents 4.9 per cent of the portfolio. Other significant holdings include drugmaker GlaxoSmithKline, bank Lloyds, and contract caterer Compass Group.
Performance of fund vs benchmark since launch
Source: FE Analytics
The £118.1m Trojan Ethical Income fund has made a total return of 27.83 per cent, underperforming the FTSE All Share benchmark’s gain of 37.42 per cent.
The fund has a yield of 2.95 per cent and an ongoing charges figure (OCF) of 1.02 per cent.