The evolution of environmental, social and governance (ESG) measures over the past 30 years has enabled a broader opportunity to understand the long-term sustainability of global companies.
In particular, over the past five years, the harmonisation and reliability of available ESG data has improved to the extent that fund managers can now assess the alpha correlations between key sustainability factors in a diversified portfolio. This data has allowed the integrated assessment of key ESG factors and the identification of sustainable companies that have repeatedly outperformed global markets since 2012.
Despite this, many investors still perceive the integration of ESG considerations as a restriction, which serves to exclude companies that do not meet specific non-financial criteria from a portfolio. Should this still be the case?
It is a question that is at the heart of the investment philosophy followed by Abbie Llewellyn-Waters. For her, the highest quality companies are those that have sustainable business models in economic, environmental and social terms.
Rather than only using traditional investment models, she enhances her analysis with sustainability measures to better assess the long-term intrinsic risk of a company, which in turn helps identify structurally sound global businesses. Importantly, in identifying companies with higher quality and sustainable, longer-term visions, Abbie looks to avoid businesses that only manage for short-term profit gain.
She explains: “In the strategy overall, we firstly aim to identify well-capitalised businesses with strong or improving cash flow characteristics and resilient operational efficiency. ESG metrics are used later to enhance this fundamental analysis and help us understand how a company is positioned on a forward basis.
“The rigorous research process takes into account financial analysis, and enhances that analysis with a range of strategic ESG considerations such as resource usage, workforce treatment, and cyber security to provide more insight into the quality of a company.”
“Importantly, we do not use sustainability as a tool to exclude stocks from the investment selection process or direct us to areas to invest. It is a completely unconstrained approach.”
The economic sustainability of a company is paramount to its success: it is after all the key driver of long-term alpha. But by applying ESG tools to an investment process in an unconstrained way, sustainability need not be restrictive.
Rather it should positively enhance the stock selection process to highlight the companies that are likely to be leading for the long term. Abbie explains: “There is a perception in the market that when investing sustainably the fundamental starting point should be ‘What sustainability theme should we target?’ [But] the more important focus for us is actually to identify companies with strong, robust and disciplined business models. Therefore, consistency of economic sustainability should underpin environmental and societal sustainability.”
She adds that when sustainable metrics are applied to stock analysis in this way, it can often reveal things about the quality of the management team or the operational approach a business is taking which help build a deeper knowledge of the company overall.
This process enables the management team to better assess risks and identify how they are transitioning to a sustainable world economy: “It is an opportunity to look at a company’s direction of travel from an innovation and sustainability perspective, as well as consider how the company operates on a broader basis.
“We can understand what its impact on the environment or society is, and how they are managing that impact. Companies who are not thinking about these risks are unlikely to be the highest quality companies in the market, in our view.”
The advancing growth of ESG reporting means there are over 400 independent data points that can be used to analyse a company today. Yet using large combinations of these to analyse a stock can often distract investors from those core areas which are most material to the long-term sustainability of a company.
In particular, using a broad-brush approach of applying all available data to ‘score’ companies run the risk of simply rewarding those that disclose information, and is something Jupiter’s Global Sustainable Equity strategy actively avoids. Instead, Abbie argues it is more important to focus on those metrics that provide applicable insight into the challenges certain companies may face.
“There are a handful of metrics that are universal across all sectors, market caps and geographies,” the manager explains.
“Those typically tend to be more socially-focused around the treatment of employees. But generically applying the same tools to all companies will not help in assessing the future trajectory of a company.
Using ESG data points in an unconstrained way during the investment process is likely to help managers identify the firms set to be ‘transitional leaders’ in their industry. Furthermore, broadening the investment analysis to include all stakeholders in the world economy suggests this type of analysis is unlikely to be the preserve of sustainable strategies for much longer, according to Abbie.
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For Investment Professionals Only. Not for use by Retail Investors. This content is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the writer at the time of writing, are not those of Jupiter as a whole and may be subject to change.