Growing demand means there is still room for further growth in the sustainable investment space, despite numerous fund launches in recent years, according to one of the industry’s longstanding practitioners: Royal London Asset Management’s Mike Fox.
A recent study by Natixis Investment Managers indicated that 62 per cent of UK financial professionals believe there is alpha to be found in environmental, social & governance (ESG) investing, while 81 per cent of institutional investors believe the style will become standard practice in the next five years.
While just 1.4 per cent of total industry assets are invested in ‘ethical’ funds – around £17bn – more funds are becoming increasingly ESG-aware.
Source: Investment Association
There is rising acceptance of sustainability in a broader social sense with consumers making more considered choices, which is being reflected in their investment decisions, said Fox, who oversees the Royal London Sustainable Diversified Trust and Royal London Sustainable Leaders Trust.
“As an individual consumer, for example, one of the most powerful ways you could have an influence on the environment – and society more broadly – is in the way that you invest,” he explained.
“Capital can and is used to promote and encourage environmental and social improvement.”
As such, sustainable investment is becoming more mainstream, said the FE Alpha Manager, although there is still further room for growth.
“When I started out in 2003, unless you were kind of wearing sandals and might have a beard, then basically it was perceived that this was an area of investment that had no relevance,” he said.
“The level of interest in the funds, which we would measure by money coming in, has grown exponentially in the last two or three years.
“My sense is, we're still very much at the thin end of the wedge, sustainable investing is still niche compared with the very broad set of people that we think it can and should appeal to.”
But growing awareness has led to the launch of a number of new funds for the industry.
“From our perspective, sustainability is sort of like a bunfight now, it's like every asset manager is trying to prove ESG credentials and so much product launch is in this area,” said Fox, who won two awards at last week's FE Alpha Manager Awards.
“I think the majority of new entrants materially underestimate how hard this is to do, how hard it is culturally and how hard operationally it is to do.”
While awareness has grown, there are still some common misconceptions about the space, and one that Fox is keen to challenge is the grouping together of funds focused on sustainability with ethical strategies.
“Ethical is very much ‘avoidance’ [and] exclusionary, while sustainable is very positive and ‘inclusion’,” he said. “And that's the simplest, cleanest way I can give people on the differentiation between ethical and sustainable.”
“Sustainability is a much more inclusive concept, you do something good with your money as opposed to avoiding something bad. And it works significantly better from an investment perspective.”
As such, Fox uses a positive screening process for his funds that takes into account two factors. Firstly, he considers whether a potential investee company and its products and services have a positive impact on society or the environment.
“Healthcare and technology will be good areas, they're often the companies in the portfolio you look at and get straight away why they're in there because they’re associated with the products or services,” he said.
Secondly, the Royal London Sustainable Leaders Trust manager will look for companies that lead their industries in ESG (environmental, social & governance) management.
“Even if their products or services aren’t the most overtly positive, we think we want to reward good corporate behaviour,” he added.
Performance of Unilever vs FTSE 100 over 10yrs
Source: FE Analytics
“Unilever, for example, and Pot Noodles. They are not the most society-positive products but the way Unilever integrates sustainability into the design, manufacture and usage of all its products is very impressive,” explained the Royal London manager.
Fox said his process works just as well for equities as it does in fixed income and that there are currently 500 companies that meet its requirements – and tend to be high-quality companies – although the equity portfolios he runs tend to be fairly concentrated in 40 to 50 names.
“We tend to find that companies which have products and services that improve society or improve the environment tend to be very innovative,” he said. “They tend to be better at growth, they tend to be less cyclical. And those are great characteristics from a financial perspective.”
From a risk-mitigation standpoint, strong ESG credentials are also important in preventing “corporate blow-ups” as was seen in the case of Facebook and Volkswagen in recent years.
Given the fact that most analytical models don’t hardwire ESG standards into the products and services of a company, the FE Alpha Manager, who also runs the Royal London Sustainable World Trust, said he has been able to exploit unnoticed market inefficiencies.
Another misconception that he is keen to break down is the idea that sustainable strategies don’t deliver good enough returns, highlighting the technology sector as one that was flagged early by his process.
“In 2013, we latched onto the cloud computing theme and we put a significant amount of our portfolios into that area. And that worked brilliantly,” he said.
“Why we did was very much the environmental analysis of cloud computing, which we felt was going to transform an industry where we all buy servers and use 10 per cent of them and they run 24/7.
“Now you can basically just rent it off Amazon for pennies and the aggregate carbon emission savings are estimated to be 80 per cent versus traditional IT and that was a pretty differentiated insight.”
He added: “By that I mean, cloud computing in 2013 was not a widely accepted concept. And, you know, and if you go back to Amazon for example, the proportion of valuation was tiny, mainly because they didn't really disclose much information on it.”
The cloud computing business Amazon Web Services is now worth $250 to 300bn, when five years ago it would have been valued at $10 to 20bn.
“Interestingly now, we've actually reduced the technology exposure in the last six months because of the societal issues around big tech and privacy invasion and so on,” Fox added.
“Life moves on, time moves on, and then we adjust the kind of portfolio positioning.”
Performance of manager vs peer group composite
Source: FE Analytics
He concluded: “I’m from Bury but Manchester was my nearest town, and I definitely don't support Manchester United, but the grudging respect I have for Alex Ferguson is that he reinvented his team over 15 to 20 years.
“I think that's a skill of a good process that, over time, it can evolve and point you in the right direction and I think that’s what we’ve managed to do."