It took the world more than 100 years to agree a generally accepted set of corporate accounting principles (GAAP). They are still not perfect, varying from country to country. But imagine what it would be like for investors if each company recorded its accounts in its own unique way. Worse still, imagine if every company used the same terms – operating profits, depreciation, capital expenditure – but each took them to mean subtly different things.
This is where we are with the language of sustainable and principled investing. Companies and fund managers use similar terminology, but the nuances differ from one to another. Fortuitously, you might think, many agencies now provide ESG (environmental, social and governance) scores for companies (and funds). But can you measure sustainability?
Scores are inevitably flawed for a number of reasons. Several hundred metrics can be applied in an analysis, and not all are relevant to the investment case. So when the results are aggregated into digestible scores, how meaningful are those numbers?
For instance, it is important to know how efficient Unilever is in its use of scarce water. It is even more important to know about pollution when you are assessing a chemical company like 3M, which is facing litigation over alleged contamination by polyfluoroalkyl. But are either as important for judging a property company like Equinix, which owns large data centres next to major internet hubs? You have to weigh how material each individual metric is from one business to another.
Any score will be based on often patchy, historical data. And attitudes change. I have a diesel car because 10 years ago the government encouraged me to buy one, saying it was better for the environment.
Scores sound impartial, but they require human judgment. For instance, ratings bodies will often have strict rules on acceptable lengths of tenure for a board and will score accordingly. We are a little more flexible.
We are likely to be sceptical if the average tenure is 12 years and a company is adopting a complete change of strategy without any changes to its board. But would we be so keen to move people on if the average tenure is 12 years, the board has done a brilliant job and more of the same is planned? Probably not. How do you incorporate that into a number?
In short, managers and investors have to operate a degree of pragmatism. We call it sense and sustainability.
These tips are not comprehensive, but they might help you in your fund selection if trying to be a good investor means as much to you as generating strong returns.
1. Don’t rely on scores alone
Funds are often scored on the sustainability of their underlying holdings, but these scores are as flawed as any – so use them with care. Active fund management is predominantly a qualitative process – does it make sense to tack on a quantitative scoring process?
2. Don’t rely on labels either
Try to understand what the labels mean to a manager. Just because a fund calls itself ethical, green or sustainable does not mean it matches your priorities. ESG is so embedded in the investment universe now that you may find a better performing fund that satisfies your needs, even if it doesn’t have a ‘sustainable’ label.
3. Look at the holding
Check out the top-10 list of companies owned by the fund (which usually appears on factsheets). We publish the top 30. Are you happy with these companies? Many funds that say they are ‘sustainable' own shares in Royal Dutch Shell, for example. The managers argue that Shell is more green than other oil companies. They might be right, but do you want to be invested in oil or not?
4. Check what is excluded
If a fund is excluding things on principle you should be able to find reference to this in its marketing literature and more information on the fund’s approach. We exclude munitions, tobacco, pornography, oil, coal and gas companies and avoid companies with poor governance. We limit exposure to countries with fragile or unreliable government – primarily emerging markets, like Russia. We try to invest in companies that we think contribute positively to society.
5. Be prepared to have your principles challenged
We are constantly being challenged ourselves. Making a paper bag uses 20x more water than making a plastic carrier bag and creates twice the carbon footprint. The fins on wind-powered electricity generators cannot currently be recycled and those rotating fins (particularly on offshore wind farms) can kill migrating birds which navigate by coastlines. Prepare to enter an ethical maze. Ultimately, we all have to make compromises.
6. Build a list of what is important for you and review it each year
For many investors, sustainability begins and ends with the environment. But as stewards of your money we think beyond that. As you research funds, you may come to realise that governance – factors like balance sheet management, how many women are on the board and executive pay – are vitally important too. In fact, in terms of materiality to share prices, governance is important in the ESG debate. We are all constantly learning new things. So your list of priorities will change over time and it should arguably change for the funds you are buying too.
7. Remember that ESG is dynamic
What was acceptable in the past may become unacceptable. Political risks can change rapidly, environmental standards and targets are shifting all the time. It can take time for this to be reflected in score mechanisms. Look for a manager you can trust to be proactive.
8. Don’t be afraid to ask a manager
A contentious suggestion that not all fund groups will welcome, but if you like a fund and are unsure of where it stands on an important matter of principle for you, do not be afraid to write to the manager and ask.
9. See if the managers invest in their own funds
For all three managers, the Mid Wynd Investment Trust and Artemis Global Select Fund are home to the bulk of our investable assets. It matters to us that it is managed sustainably, so you can be sure we will stick to our principles. After all, we hope to be able to pass on some of our holdings to our children and grandchildren.
10. Don’t forget performance
As long as you are not too restrictive, sustainable investing should not impair your performance. In fact, it has been positive for us during this crisis because it has helped us avoid sectors, like oil and airlines, that have been worst hit.
Alex Illingworth is manager on the Mid Wynd Investment Trust and Artemis Global Select fund. The views expressed above are his own and should not be taken as investment advice.