ESG: a trend we can’t afford to ignore

What is the ideal soundtrack for ESG (environmental, social and governance) investors? There is one classic song that has been covered by some of the greats — Frank Sinatra, Diana Ross, Ray Charles and Van Morrison, to name a few. But in my opinion the original performer has never been bettered. 

Kermit the Frog first sang “It’s not easy bein’ green” in 1970. Voiced by Muppets creator Jim Henson, it became a hit, telling a sweetly thoughtful tale of how Kermit’s doubts over his colour dissipate as he comes to recognise the positives in his appearance. 

If you’ll forgive the leap, it is also rather a good metaphor for sustainable investing — an idea we can no longer expect to arrive some time in the future, but is already here with us.

Back in the 1970s, the notion of being green was largely a fantasy. The oil shortage was looming, which in the UK gave us the three-day week. That traumatic period demonstrated the dangers of global overdependence on fossil fuels but the lesson was not learnt. The revolution had begun but took decades to take hold.

It is a different story today. This year the pace of green change has rapidly accelerated as a byproduct of the pandemic. Car usage plummeted and business and long-haul holidays were suspended, deferred or cancelled. Some of this travel is unlikely to return, even with a successful vaccine programme.

Deliveries of shopping and goods were made in bulk. Instead of 50 people driving to the shops, one van delivered. Amazon never left my street, but neither did the cars.

These trends have their corollary in investment. Being green is becoming so ordinary that a 2020 study by the US SIF foundation, a membership organisation focused on sustainability, found that roughly one out of three dollars invested in the US — or $17.1tn — has a sustainable mandate. That is a lot of green. 

As a wealth manager, I can also say the trend has been driven not only by the investment industry but by its clients. In conversations over the past 18 months with families and individuals I advise, green investing has become a big priority for them, either because they wish to invest in a future-proof way, or because their children have asked probing questions about where their money is invested — and millennial and Gen Z children are keener than ever not to inherit what they think of as “dirty money”.

Another motive can be a guilty conscience. One client sought a sustainable investment portfolio for the money they had made from the sale of their business — a cement manufacturing business that had caused years of environmental damage. 

Opportunities for sustainable investment used to be scarce, but today it is hard to find a company that does not have an ESG policy. Nine out of 10 of companies in the S&P 500 index produced sustainability reports in 2019. This creates a fresh set of problems: how do you decide when a business is genuinely motivated by these concerns and when its ESG claims are hot air?

For professional investors, it means company visits and interrogating management and the financials. For private investors without privileged access, it can be far harder to sort the green from the greenwash. Take those firms that trumpet their carbon neutrality by trading off the harmful parts of their business with offsetting green initiatives. Investors must ask hard questions of these activities. Are today’s emissions, for instance, really justified by tree planting that will take 30 years to deliver benefits? 

Some companies fall into the category of businesses that are set up with the aim of doing good. Among the investments in my firm’s sustainable fund, for example, is Renewable Infrastructure Group, an investment trust with assets generating 8tn watts of clean energy a year and avoiding 1m tonnes of CO2 emissions. Or there is Greencoat UK Wind, an investment fund focused on UK wind farms. Another is Equinix, a digital infrastructure company.

What about the rest, though? Should investors expunge all those companies that have yet to show themselves sufficiently committed to the ESG agenda? 

Not always. Many sustainable fund managers — including our own — reserve a portion of the portfolio for actively intervening in companies that need an extra nudge, using the voting rights that share ownership affords them to try to change the companies from within. This may mean exerting pressure when it comes to strategy, remuneration or governance rules. 

This approach can be a bone of contention when I speak to clients who want to put more of their money into ESG. They ask for any ethically unproven companies to be excluded. But the more bars are applied to a portfolio, the harder it is to make money and find appropriate investments. What is more, applying the principles of ESG to specific companies can reveal stark differences of opinion between investors over what constitutes a “good” or “bad” business. 

ESG fund managers are capitalists. They are investing to make money — they might do some good, but that good has to lead to return

Many sustainable funds, for instance, include credit card companies in their investments, on the grounds that they provide lower income families with a vital financial lifeline as they struggle to make ends meet from week to week. Others see these companies as levying a tax on the poor, charging exorbitant interest rates and leading people down the road to debt. The truth is that there are few investments that will leave everyone feeling entirely comfortable. 

Which brings me to the question I still hear regularly from clients: How much performance do I need to give up?

In my view, the answer is none. ESG fund managers are capitalists. They are investing to make money — they might do some good, but that good has to lead to return. The evidence supports this: a study in June by Morningstar found that most sustainable funds had outperformed non-ESG funds over one, three, five and ten years. 

So look at your investments and ask yourself — are they ready for the 2020s and can you help change the world? I am not advocating going vegan — I’ll leave that column to Miss Piggy. But ESG is here to stay. As Kermit concludes: “I am green and it'll do fine. It's beautiful, And I think it’s what I want to be.” He accepted the green revolution. Will you?

Michael Martin is private client manager with Seven Investment Management (7IM). The views expressed are personal. Twitter: @7IM_MichaelM