Environmental, social and governance (ESG) issues flagged up by the team at Schroders allowed the then largest shareholder in Carillion to exit its stake long before the company went into liquidation last month.
ESG issues have been of growing importance to investors, with 75 per cent of institutional investors questioned by the Schroders global investor survey noting they would significantly increase their allocation to sustainable investments.
However, how to go about this remans confusing, with some 78 per cent of respondents admitting they find it incredibly challenging to do so.
Source: Schroders
Jessica Ground, global head of stewardship at Schroders, said: “We take this holistic view – in fact we are quite negative about a very narrow view of ‘green’ [investing] as there is quite a lot of ‘greenwashing’ in there.
“I have been investing for 20 years and I have yet to find a perfect company. People who tell you they are just giving you a portfolio of perfect companies inevitably have companies like Volkswagen in them – which they all did.
“That can be a hard message to understand but what we are trying to do is understand risks and engage to mitigate them.”
The biggest concern among investors is still one of performance with the idea that investing sustainably is going to impact returns still a misconception in the market.
Ground said the industry has become more sophisticated in recent years, moving on from the basic screening process which can indeed hamper returns.
“We have just written a paper looking at negative exclusions with different investment styles and so actually if you are going to exclude oil and be a value investor that is pretty challenging,” she said.
“What [ESG] is about is having grown-up conversations about what people want to achieve. If it is that people do not want to invest in things then it may well be about sacrificing investment returns – you can imagine what excluding tobacco has done to your portfolio.”
Yet for investors who are less concerned by ESG, it still has a place in aiding fund managers to avoid potentially devastating mistakes.
In 2015, Schroders was the largest shareholder in outsourcing firm Carillion which was recently placed in liquidation following after collapsing with huge debts and pension liabilities.
Performance of stock since Jan 2015
Source: FE Analytics
One of the issues that has arisen since in the wake of Carillion’s fall from grace is issues with remuneration of the management team.
Former members of the team had deals in place whereby they were still being paid after leaving the company – a process known as clawback.
Ground said what typically happens is that the ESG team go into companies and ask to be remunerated from former managers that are still receiving a salary or bonus payments despite, in some cases, being fired for poor performance.
However, they are often told that while their policies say there are clawback options, in reality, these are unenforceable because they are not put in contracts.
“We can look at what the policy says a but the policies on clawbacks are not worth the paper they are written on,” she noted.
“Tell me an executive that has done clawback other than voluntarily? It doesn’t exist. So the system is broken and there is a real issue with how we get people’s money back for all of our beneficiaries.”
Ironically, Carillion was a bit more honest about the contractual position that they were in, she said.
But in 2016 the firm announced change to clawback bonuses. While previously the firm had the right to reduce bonuses not yet paid, after changes these provisions could only be applied if financial results were incorrect.
While this is an extreme example, there are others that highlight how ESG has become a factor for investment managers.
Using climate change as another example, Ground said irrespective of whether people believe it to be true or not, legislation is being put in place that could impact companies’ balance sheets. 
“We have done analysis of the risk between two different utilities on their profitability and one [that ignores these issues] is down 30 per cent while the other is up 30 per cent,” she said.
As such, ESG investing has moved a long way from whether or not an investment is ‘green’ and is more about assessing the impact of events and issues.
“If it is about investing with a fund manager who is really lobbying on climate change [for example] because it is a huge financial risk. That isn’t about giving up financial returns, it is about having proper impact with your money,” she said.
As such, the ESG team has looked at working alongside other departments, with the asset manager’s well‐known value team using it as another part of their process.
Ian Kelly, manager of the Schroder Global Equity Income fund, said: “We don’t think about it as being any cost – we think about ESG as being like balance sheet risk.
Yet, while it is hard to bring the debt down of a company, those failing on ESG measures can be engaged with, making them a better company and improving returns.
“I used to be very sceptical as the value team tend to be quite contrarian and don’t believe in forecasting the future but it is very much about the material risks of losing money from a business,” Kelly (pictured) said.
“When it gets integrated into what we do we think about it in the same way as we think about cashflow conversion and balance sheet risk.”
Ground added that while the out‐of‐favour areas such as retailers, oil and miners offer challenges, by using ESG it allows the teams to know how much risk they are taking on more than just what’s on the balance sheet.
“Being ESG integrated to the value team does not mean that they don’t buy mining, it means that they have really thought about the structural changes and means they are really engaging with stewardship,” she said.