ESG investing

Dan: Interest in ESG investing is growing. Here to talk about what it means for investors is Fidelity Investment Director Tom Stevenson.

Tom, thanks for coming in. So ESG, another three letter acronym for investors to get used to, first of all what does it stand for?

Tom: Yes, we’re terrible with these acronyms aren’t we? In fact there are two related to this style of investing. There’s ESG which I’ll explain, but there’s also SRI - socially responsible investing, but ESG, what does it stand for?

The E is about the environment, so this is looking for companies and investigating the impact that they have on the environment around them. So it might be looking at issues around pollution, for example or water, waste management, climate change, all of those kinds of issues.

The S is about society or social aspects, so this might be looking at employment practices of companies, making sure they’re not involved in modern day slavery for example, just looking at how they treat their employees.

The G is about the governance, so this is about how a company fits in with the regulations surrounding its industry for example but also issues around senior manager pay for example, that’s a big issue in governance at the moment. So that’s ESG.

Dan: And why are these topics coming to the fore now, why are they a hot topic all of a sudden?

Tom: Well, I think there are a couple of reasons, I think the first reason is this growing body of evidence that actually companies that take ESG seriously are actually the better companies. If you care about the environment, you care about the sustainability of your business model, you care about your employees, you care about managing your business well with good governance, then the chances are you are a better company. So for an investor these are really good signposts towards good companies.

I think the second reason is the sort of warm and fuzzy thing which we associate with maybe ethical investing. I think increasingly people are concerned about putting their money to good use, they don’t want to be backing companies that they feel are doing the wrong thing. They want companies to be aligned to their values.

Dan: And is it a case of identifying these companies, or is it a case of filtering out companies that don’t fit with your morals?

Tom: Well I think it’s both of those and indeed I think it’s even a bit more complicated than that. I think at one end of the spectrum you’ve got funds which are actively excluding companies from their portfolios because they’re involved in activities which they don’t agree with. So that might include arms manufacturers, it might include tobacco companies or publishing companies involved with pornography for example.

At the other end of the spectrum I think you’ve got investors looking for companies that are making a positive impact on society and the environment. This is sometimes called impact investing. And then in the middle I think this is actually the more interesting area. This is where investors are

looking to engage with companies to help them become more sustainable and to guide them and to learn with them about how they can become better long-term companies.

Dan: Now often some of the criticism levelled at this end of the market is that you have to sacrifice some returns for morals. If you think about traditionally the companies we talk about in these conversations, like tobacco, or arms which might have been very good investments but are instantly ruled out. Is there still a case that you have to give up one to get the other?

Tom: I don’t think so, in fact it might also be the opposite. It’s true that if you are excluding a group of companies from your portfolio then by definition you’ve got a smaller universe which might impact your ability to derive good returns from your portfolio. But as I was saying earlier on, I think that actually companies which exhibit the characteristics which an ESG style of investor is looking for, the evidence is that they tend to be better companies so actually I think a sustainable approach to investing actually is likely to lead to better returns not worse returns.

Dan: So you could say that sustainability is around the returns, sometimes maybe the ethical or moral question plays second fiddle really. Why is it important to play this theme or explore the area in a mutual fund?

Tom: Well I think there are good reasons to invest in funds generally, one of the key reasons is around diversification. As an individual investor it’s quite difficult to put together a broad enough portfolio to give yourself the security of that diversification. A fund can do that relatively easily. I think the other reason is that you’re engaging professional and specialist management so an investor who is focused on sustainability really understands the issues and is able to engage with companies in a positive way has skills which maybe as an individual investor you don’t have. So I think for those two reasons doing it through a fund is a good idea.

Dan: A great introduction to ESG, thanks very much Tom.

Tom: Thanks Dan.