A sacrifice on returns and a guaranteed underperformance. Those are just some of the misconceptions about responsible investing that have persisted over the past 20 years, according to Kames Capital head of ESG research Ryan Smith.
“There have been many theories over the last few decades about responsible investing and how it fails to offer as good an opportunity broadly to investors,” Smith said.
“However, the facts are very different. Companies which do not give any consideration to their responsibilities to everyone beyond their shareholders are increasingly in the spotlight for the wrong reasons.”
He cited Beyond Meat – the billion dollar plant-based meats manufacturer – as an example of a company whose success was brought about by its sustainable outlook amd is “helping to change some of these ingrained biases” in the industry.
Beyond Meat’s stock market performance
Source: Google Finance
Coming towards the end of Good Money Week, Smith discusses four common myths and misconceptions surrounding environmental, social and governance (ESG) investment.
Myth 1: There is no place for ethics in investment
Smith uses Michael Douglas’ Oscar-winning amoral character Gordon Gekko – a cult icon for 1980s-style avarice, living by the maxim ‘Greed is good’ – as an example of how investors should not be acting today. Unlike Gekko, investors should play close attention to how are company operates and the effect it has on the wide world.
“We think there is value in judging a company on the sustainability of its products or services,” Smith said. “Gordon Gekko didn’t do lunch and wasn’t strong on ethics. Gordon (as they say) would sell his granny.
“Industries or companies that perform no social function are inherently unsustainable. They impose costs on society and ultimately, it is highly probable that such activity will simply be regulated out of existence. The sustainability of a company’s products or services is therefore vital to its long-term strategic success.
“Strategic positioning and vision can be a long-term tailwind or headwind. An unsustainable product (e.g. coal) is a huge strategic headache for any management team, just as a sustainable one should create a tailwind of opportunities.”
Myth 2: Thinking sustainably is a downside risk tool only
The second myth Smith addresses is the idea that incorporating a responsible or sustainable lens onto an investment process is only useful for when seeking to limit the potential downside.
He conceded that a lot of ESG research is to do with “avoiding controversies and disasters,” noting that thinking about sustainability can actually improve an investors downside protection when combined with other metrics.
But, Smith said, this isn’t the full picture.
“Risk is a backward-looking measure,” he said: “Thinking sustainably promotes a long-term focus, helps us to avoid short-term distractions and can also be useful for identifying sources of competitive advantage.”
Applying this to Kames’ own ethical and sustainable strategies Smith said the firm looks for investment opportunities in growth stocks.
In this part of the market, according to Smith, there appears to be a higher chance of finding disruptive and innovative companies that are “more likely to provide responsive investment opportunities and be willing to engage and improve”.
Myth 3: Just invest in the best
“There are an increasing number of ESG products being launched, many of which use off-the-shelf third-party ESG ratings to construct their portfolios, or indices,” Smith said.
“In most instances, they adopt a ‘best-in-class’ approach; because the best ESG companies must be the best investment right? Maybe, but in our experience, it’s often a bit more nuanced
“‘Best-in-class stocks’ according to these ratings also tend to be large-cap, well-known and well researched, and hence provide less opportunity for mispricing opportunity to capture alpha.”
According to Smith, this bias displayed by most ESG funds is “fine” for Kames Capital since it focuses on the more unresearched small and mid-cap market, where it believes there are “better investment opportunities”.
“And to provide our clients with the breadth of negative screens that they seek, our ethical funds are always actively managed,” he added. “Then, once invested, we take our stewardship responsibilities very seriously; meeting with management, challenging them and, if we need to, selling our position.”
Myth 4: Profits vs. principles
The final myth which Smith tackles is the idea that to invest in an ethical manner means “giving up returns".
“Empirical evidence supports the premise that thinking carefully about sustainability as part of an investment process can enhance investment returns,” he explained.
Smith argued that investing is all about consistently using a set of tools that can tips the odds in your favour and he sees sustainability analysis is one of these tools.
“Sustainability analysis is one of these tools and it fills a key role in our toolbox, but it’s one which many investors still don’t consciously utilise,” he concluded.