Harry Merrison demystifies ESG terms and considers potential investment themes, from water sustainability to gender equality.
With more than £24 trillion in assets globally, an increase of 34% in just two years, it is unsurprising that environmental, social and governance (ESG) investment dominates headlines. In an industry that is predicted to continue to grow significantly between now and 2025, there are countless options for investors who have a desire to invest in line with their conscience.
The dichotomy of knowledge was evident at a recent ESG forum that I attended; the investable universe is both expansive and opaque. In this article, I will demystify several seemingly interchangeable terms and peek under the bonnet of potential investment themes.
ESG is a set of standards seeking to reduce negligent corporate behaviour that may lead to environmental degradation, armament sales, human rights violations, racial or sexual discrimination, harmful substances production, worker exploitation and corruption, although this list is by no means exhaustive.
It is widely accepted that companies that incorporate better ESG risk management can generate better long-term risk-adjusted returns for investors.
Investing in key ESG themes
The above description of ESG defines an array of key themes that forward-thinking investors could incorporate into their portfolios. Thematic investing is unconstrained by traditional geographic and sector demarcations focusing rather on top-down systemic shifts. By this definition, within ESG, investors can pick multiple themes evidenced by recent trillion-dollar inflows. For example:
BlackRock Sustainable Energy Fund: In 2016, 196 world leaders signed the Paris climate agreement, a legally binding pact that committed all signatories to action on climate change for forthcoming decades. Millennials have grown up with climate change warnings, carbon neutral targets and the transition to clean energy.
Reassuringly, figures show that internal combustion engine production peaked in 2018; arguably one of the most significant inventions of the 20th century is now in decline as the world moves towards cleaner hybrid and electric technology.
Currently, around the globe, fewer than 1% of vehicles are fully electric, which represents a significant growth opportunity given the inevitability of the technology’s future monopoly.
The BlackRock Sustainable Energy Fund invests globally, with at least 70% of its allocation to sustainable energy companies largely specialising in wind, solar, and energy storage.
Managed by Alastair Bishop & Charlie Lilford
Fund size: £887 million
Lyxor Global Gender Equality: Lyxor research finds that up to $28 trillion could be added to global GDP by 2025 if full gender equality is achieved in the workforce.
The Lyxor Global Gender Equality exchange traded fund aims to track the Solactive Equileap Global Gender Equality Net Total Return index, an equally weighted benchmark of 150 companies from around the world that score highly for gender equality, according to the 19 criteria defined by Equileap, an independent gender equality research organisation.
The Lyxor ETF offers transparent, liquid and low-cost exposure to the diverse underlying benchmark index, which includes companies such as Biogen, Nvidia and SAP.
YTD performance +21%
Fund size: €14.3 million (Very small)
Rebeco Sustainable Water Fund: As the global population swells to a predicted nine billion by 2050 and the world becomes increasingly urbanised, sustainable and uncontaminated water sources will be even more imperative for crop cultivation, disease prevention, and human survival. Robeco predicts that water demand will rise by approximately 40% until 2030.
The Rebeco Sustainable Water fund has almost £1 billion under management and invests worldwide in listed companies specialising in irrigation services, water analysis and treatment technologies.
GAM (Luxembourg) S.A.
Fund size: £982 million
Impact investing positively screens candidates on their ability to generate favourable influence on society and the environment, as well as minimising any detriment. The intangible, non-monetary benefits of impact investing can be mapped against the United Nations 17 Sustainable Development Goals as a scorecard for assessing whether the right issues are in focus.
SRI generally focuses on excluding “sin stocks” from the investment pool based on negative screening guidelines. This results in the selection of companies with strong SRI characteristics, such as those that have a positive influence on society or the environment. One of the objectives of this screening process is to positively influence corporate behaviour.
The MSCI SRI World Index contains just 392 constituents, which is fairly concentrated compared with the MSCI World ESG Leaders Index at close to 800.
The inherent subjectivity of the competing ESG methodologies leads us to a caveat emptor conclusion. Investors need to take an in-depth look at the fund, including the underlying equity holdings and how much of the fund is invested in each; this is the only way they can ensure they are investing money in line with their principles.
Harry Merrison, investment manager and vice-president at Kingswood.