Nick Watson, fund manager on the UK-based Janus Henderson Multi-Asset Team, argues that understanding a company's environmental, social and governance risks can be vital in enhancing clients' long term returns.
Financial institutions struggle to break free from the negative connotations of fictional character Gordon Gekko’s famous phrase "greed is good" from the movie Wall Street. However, all of us engaged in the world of investments, and the wider population, must recognise that financial markets are driven by those with capital looking to invest and grow their wealth. This extends from the Norwegian Sovereign Wealth Fund to parents investing monthly £50 contributions into ISAs for their children.
The challenge for the Janus Henderson Multi-Asset Team, and the money that we actively manage on behalf of your clients, is to identify those investments that can deliver wealth creation in a sustainable manner. Because, frankly, that is what most investors want – investments that deliver sustainable returns over the long run.
That is not to say that the only parts of the market suitable for investing are those involved in clean energy or that companies engaged in mining operations or animal testing should be excluded from client portfolios. Indeed, our stance is that the high quality active managers to which we allocate your clients’ capital should be given the fullest flexibility to deliver outperformance on their behalf.
However, from a risk perspective, we expect all of the managers that we invest with to be fully aware of the challenges faced by the stocks they own. Identifying the environmental risks (for example, oil wells in the Gulf of Mexico), social risks (such as data leaks from social media companies) and governance risks (that could include minority shareholder interests being ignored) that a business faces can be just as important as the conventional financial analysis conducted by stock pickers.
Recent examples include businesses as diverse as BP, Volkswagen and Facebook. All three are incredibly successful businesses in their own right and within their own sectors. However, each suffered from damaging risk events that, while not predictable, represented the realisation of underlying risks that would not be captured by trawling through cash flow statements.
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A sustainable lens: the vital role of ESG
Companies with business models that are vulnerable to events, regulatory developments, fines or corporate misbehaviour do not offer the level of sustainable long-term returns that those already addressing their environmental, social and governance (ESG) challenges can.
Using these additional risk metrics alongside bottom-up financial statement analysis gives fund managers an additional lens through which to develop their valuation for a company. In this world of 24-hour news and efficient markets, incorporating ESG elements in a stock selection decision not only gives such a fund an information advantage over its competition, but can also help it to avoid those unwelcome news 'torpedoes' lurking in some industries by more fully considering risks and sizing its positions accordingly.
Clients benefit over the long run from the more informed decision making approach of fund managers with a focus on more sustainable and less risky returns; companies benefit from engaging with their shareholders and focusing on those businesses that deliver sustainable long-term earnings growth; and everyone else benefits from those companies’ drift towards more sustainable business models.
Many clients, and chunks of the market, view such ESG factors as a ‘niche’ or ‘green’ part of the market employing negative screens. Other investors already do this work but shy away from using the term ‘ESG’ within their investment process to avoid being pigeonholed. Such distinctions do not bother us as long as the work is being done.
However, we would argue that if a fund manager is not fully assessing all of the risks, both financial and sustainable, in their stock picking decisions then they are not fully doing their job and should not therefore be trusted with your clients’ capital.
On the Janus Henderson Multi-Asset Team, we recognise that greed IS good and that without it, financial markets would not function and capital would not flow to those businesses that need finance to grow and to employ more staff.
Incorporating ESG into an investment approach can ensure greed remains good for financial reasons that are less easy to measure tick by tick, or day by day, on a Bloomberg screen, but that are increasingly important for enhancing long-term returns for clients.