The growth of ESG (Environmental, Social and Governance) has been a hot topic in the investment world for several years and is increasingly seen as central to portfolio construction. ESG metrics are now commonly used alongside more traditional financial metrics, such as leverage and valuation ratios. A company may have a strong balance sheet and attractive valuation ratios, but investors will now evaluate a firm’s environmental, social and corporate governance standards before diving in.
Intangible assets comprise a large component of corporate valuations. If those intangibles become impaired shareholders can take a hit. To take an example from the real world, think back to the early 90s (for those, eh hem, closer to my age…) when Shell airily announced its disposal of the Brent Spar oil platform by simply sinking it in a North Sea trench.
When its sales plummeted and environmental groups rallied a fierce opposition, the shocked company came up with a new plan to dismantle it, and in the end decided to just re-use it.
By 2017 when Shell needed to decommission more North Sea platforms, they took a very different approach. Working with fishermen, environmental groups and academics, the company developed a comprehensive disposal plan that was widely accepted.
This radical change in behaviour is not only because Shell is conscious of its ESG rating, although it most certainly is. It is also the example from the public reaction to its environmental carelessness, demonstrating very clearly that its behaviour can impact revenues in the real world.
ESG metrics matter because the wider public has decided that the environment matters. The social impact a corporation has is looked at similarly. And higher governance standards ensure that companies are less likely to engage in nefarious activities. Although, human nature being what it is, we still get our occasional VW Dieselgates, Enrons, Theranos’ and the rest.
Those scandals, however, have only heightened the use of ESG when looking at a company’s value. In order to dodge the bad actors and allocate capital to the good ones, ESG metrics are crucial.
And capital markets being what they are, ESG is not just an equity tool but one that debt holders need to evaluate as well. It’s the same company that is being financed, so while financial metrics can discriminate between equity and debt, ESG metrics don’t. A tobacco company is a tobacco company. If you don’t want to own a tobacco company in your equity portfolio, I’m pretty sure you don’t want to lend them any money through your fixed income portfolio either.
Similarly, if you are building a portfolio and you have sustainability in mind, then ESG metrics will be used across asset classes.
Which is why eInvest provides actively managed ETFs that use ESG metrics at the centre of their portfolio construction in both equity and fixed income. The eInvest Better Future Fund (Managed Fund) – IMPQ – has clearly demonstrated that ESG does not hurt performance. Quite the opposite – with IMPQ up 38.7% in the past year, 6.4% ahead of its benchmark.
Our actively managed fixed income ETFs – ECOR (core income) & EMAX (income maximiser) – also use ESG data. With expert managers to navigate our historic low interest rate environment, they avoid dodgy ESG companies and have adopted a low duration exposure, so the funds have had a positive performance in every month this year and are up 3.1% and 5.75% in the year to the end of July, respectively, while the Ausbond composite index is up only 0.8%.
ESG isn’t the only data you need to build a great portfolio. Traditional financial metrics are still critical. But ESG brings risk management to the table by avoiding stocks with low ratings, and as an investor, it allows your money to be invested in a manner consistent with your values. Which is why ESG has been such a hot topic, and why it will continue to grow in importance.
Disclaimer: Please note that these are the views of the author, Tamas Calderwood, Distributions Specialist , eInvest, and is not financial advice.
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