Taking a sceptical approach is vital when investing with an ESG (environmental, social & governance) lens if you want to make money from this area of the market, according to Neil Brown, manager of the Liontrust UK Ethical and Sustainable Future UK Growth funds.
Brown uses a focus on sustainability to deliver financial performance in his funds, but accepts that many investors still cling to the notion that one comes at the expense of the other.
Part of the reason for this distrust may lie in the poor performance of the first renewable energy funds – launched in the early part of the millennium, many have struggled to eke out a return.
Performance of funds vs index over 10yrs
Source: FE Analytics
While the manager said investors shouldn’t forget the lessons of the past, he claimed this area of the market has been transformed over the past 20 years.
“The industry that I work in now compared with the industry I joined is incredibly more professional in terms of the tools we have and the data that companies give us,” he explained.
“I just came from UBS’s mainstream conference. Plastics were discussed, new textiles were discussed. There is proper data on the amount of money that’s being made and the investment that has gone in.
“People are processing that new data in a materially better way than they ever used to and they are making better investment decisions.”
However, he added: “You should be extremely sceptical about all of it and to be honest with you, as the years go by, that’s the only thing that’s going to save those of us who are really doing it.
“The questions that are asked. The drilling into the real detail. Which stock do you think is going to do better?
“It’s because you’ve done this analysis, and if everyone does that, then this will work.”
Part of Brown’s approach involves screening out companies that don’t fit his view of what is sustainable. The manager said a common criticism of ethical funds is that they can’t hope to outperform if they automatically ignore large parts of the market. However, he pointed out this is the very definition of active management.
“My job as a fund manager is to take 442 stocks in Europe and get to the 40 that we think will go up,” he explained.
“Removing them is the entire job, what I’m trying to do. We are bottom up, so we do find companies in other ways. But let’s be honest, excluding stocks that – on a cost/benefit analysis – we don’t think society is going to want in 50 years, this is a fantastic way to make money. So that’s what we’re looking for.”
While Brown won’t invest in oil & gas as he believes the sector could well be worthless within 50 years – if not before – the same could have been said about cigarettes at the turn of the millennium. With tobacco companies in the US hit by multiple lawsuits in the late 1990s, society appeared to be turning against the sector and its days looked numbered.
Despite these headwinds, it turned out to be the best-performing area of the market over the next 10 years, with the FTSE 350 Tobacco index rising by 742.82 per cent in a decade in which the wider index barely broke even.
Performance of index over 10yrs
Source: FE Analytics
However, Brown said that 10 years is too short a time frame to judge the worth of his strategy.
“The cost/benefit analysis that we did in 2001 said that although tobacco is making money, it faces serious issues that mean over the next 30, 40 or 50 years, it’s going to be harder and harder to sell a cigarette.
“You can choose a 10-year chunk: but someone investing on a 30-year or 40-year time horizon should ask ‘what does the world want more of?’ It’s not what do I personally dislike that might do very well.
“We just want companies that don’t face massive headwinds from society saying en masse, ‘we don’t want this’. And that’s what we look at more than anything else. It’s not anyone else’s personal view. It’s ‘what is society moving towards and what is it moving away from?’ A lot of money will be made in pockets of that.”
If the manager is correct, however, and investing in sustainable themes does prove to be a major tailwind, won’t this eventually be priced in? More importantly, with the Global Sustainable Investment Alliance reporting $30trn now sits in sustainable investments, a figure that has risen by 43 per cent since 2016, is there a danger that a bubble could be inflating in the asset class?
Brown said there is no evidence of this so far.
“We are using sustainability to deliver financial performance, [but] we only use it when we believe it can deliver material financial performance,” he continued.
“We are looking further than others: I think the whole world’s going to eat more healthily, we’re going to travel more by train.
“At the moment we are not seeing a crowded-out trade. We’re not seeing a rail stock that because everyone has launched an impact funded is suddenly on 50x [earnings]. The only conclusion is there might be a gulf between what is being said and launched. We are definitely not seeing the flow of money at the moment.
“But if you’re doing that sort of detailed work, we will see it and we’re not going to pay up for a stock just because it appears to be a bit of an ‘ESG stock’. We like stocks on the right side of history that are making money and are attractively valued. We’re pretty relaxed at this stage.”
However, while the manager said he is not seeing a flood of money into ESG stocks at the moment, he said there is every reason to believe it could be on the way. And, he said it would be prudent to buy into the sector before it arrives.
“We now know how our T-shirts are made, so we have changed the way we buy our clothing,” Brown said. “If we knew what our money was doing, what was being done in our name, I’m of the belief that a lot of people would make different decisions about where it was invested.
“And again, that’s the message: if you can close that loop, if you can close that last bit of transparency, so people really know what’s being done with their very hard-earned money – frequently money that has not been earned in these activities that are challenged – they would probably continue to switch a lot more of it.
“The theory of that is considered to be the last bit that unlocks this,” he finished.
Data from FE Analytics shows the Liontrust UK Ethical fund has made 311.76 per cent since launch in May 1999, compared with gains of 177.52 per cent from the IA UK All Companies sector and 134.61 per cent from the MSCI UK index.
Performance of fund vs sector and index since launch
Source: FE Analytics
The £507m fund has an ongoing charges figure (OCF) of 0.86 per cent.