Investors shouldn’t take an exclusionary approach to ESG investing in small-caps as ratings agencies may penalise companies that lack the resources to publicise their achievements in this area, according to Kirsty Desson of Aberdeen Standard Investments.
Desson co-manages the £1.6bn ASI Global Smaller Companies fund with Harry Nimmo. While a focus on ESG factors is an important part of the managers’ process, they do not screen out companies that score poorly in this regard.
“We don’t have an exclusion list as such, because of our process and the fact we focus on quality companies and look for sustainable growth that tends to shy away from cyclical, heavy-industry type stocks,” she said.
Desson added that it can be difficult for small caps to achieve high ESG scores given they may lack the resources to focus on this area. She also said that many of the companies that are committed to ethical and sustainable practices may not disclose or publicise this in a recognisable way.
“In Japan, a lot of companies are doing great things on the ground, but they don’t put them on their English-language websites and they don’t get picked up by MSCI,” she continued.
“It’s about working with management to get them to disclose and engage with MSCI.”
Desson likes to engage with management teams directly, saying they are often open to making their business practices more ethical and sustainable. She cited ALS, an Australian laboratory-testing provider, as a small-cap ESG success story.
“Given the sector, we thought the ESG rating might be quite poor for the company, whereas in fact it was the complete reverse,” she said.
“It’s the chief executive leading the charge on this, and daily reports come in with a range of data on safety, oversight and customers.”
Away from ESG, Desson said 2020 was one of the best years in terms of relative performance for the fund. She added that its quality focus means it often tends to do well in down markets.
“Whilst a lot of companies had no visibility in their earnings, the companies that we’re looking at were still able to operate and had the balance sheet strength to ride out the Covid uncertainty.”
However, since ‘Vaccine Monday’ and the value rally that followed, things haven’t been as straightforward and performance has lagged – although the fund is still in the second quartile of its sector.
“When we’ve been through these value rallies before, as in 2014 when the Fed started to taper its bond purchase programme, the fund tends to underperform.
“On a simplistic basis, we’re six months into this value rally and we’re starting to see the fund outperform again.
“Now we’re at an interesting point of the cycle as some of that easy money has been made and it is now a stockpicker’s market over the next six months.”
Desson added that this is the case in a number of markets that have plateaued, including China, Japan and others in the emerging markets.
“In all those markets, you’re starting to see quality-normalisation coming through, and while western markets are still hitting new highs, there are certain indicators that these two are peaking,” she said.
This is best illustrated by the factor returns over the last six months, the reverse of those that did best in the value rally.
Factor returns from March 2020 – present
Source: J.P Morgan
A proponent of factor investing, Fahad Hassan, chief investment officer at Albemarle Street Partners, said that managers conscious of protecting performance can engage in style-drift and move away from their process.
Desson said: “It’s hard to remain disciplined when you’re seeing underperformance coming in. But we know the process works over time, and the periods of underperformance are short-lived, so it’s important to stick to our guns and follow what we do.”
She added that one important differentiator to the fund’s pure-quality peers is the momentum element.
“That allows us to find these stocks that are seeing upward earnings provisions or upwards price momentum.
“There is still the long-term growth story, but there is a cyclical pick-up, and capturing stocks that are re-rating is an added kicker.”
Performance of fund vs sector since launch
Source: FE Analytics
Since launch, ASI Global Smaller Companies has made 332.81 per cent, while the average fund in the IA Global sector has made 189.62 per cent.
It has an ongoing charges figure (OCF) of 1.05 per cent.