While societies survey the damage caused by Covid19, the focus on sustainable business models, fair social contracts and environmental impact mean Newton Investment Management’s head of sustainable investment Andrew Parry is suddenly fashionable, perhaps for the first time in 35 years.
With corporates scrambling to adjust business models to be more resilient, and the understanding that industry dominance and monopoly may stifle job creation and suffer the ire of antitrust regulators, Parry has cautioned investors against rushing blindly towards the shiny ESG label.
“There’s been a tsunami of money into the ESG sector, particularly into passive,” explained Parry, in an interview with Investment Magazine’s Market Narratives.
“But if they’re looking at just the label and the score and not enough about the other variables… it could hinder your ability to outperform.”
Newton portfolio manager Aron Pataki will appear at Investment Magazine’s upcoming Absolute Returns Conference September 23-24 on the topic ‘Investing by thematic: Deciphering the trends’; reserve your digital access to the conference here.
The monopoly risk
Technology stocks, benefitting from the global shift to online working, and their entrenched monopoly-like positions, could pose a destabilising risk to ESG portfolios as governments look to enforce the “Social” in ESG.
“There are real worries about the over-concentration of market share,” said Parry, pointing to platform companies with eyes on real-time data flow all through the system enjoying an unfair advantage, and one that suppresses the “beating heart of entrepreneurialism”.
However, Parry also suggested the danger of creating unassailable moats is likely to coax regulators towards addressing the imbalances this introduces into populations.
“When things become ubiquitous, they often become stripped of their utility,” said Parry. “And there is a danger of a compounding effect of momentum in the darlings.”
Despite the $US7 trillion worth of stimulus, there might be a regulatory swing from environmental towards social.
“If we have sticky unemployment and a slower recovery than anticipated, then questions will be asked of dominant industries,” said Parry. “So investors and asset owners will need to watch this closely.”
It’s the companies, stupid
The sudden, devastating effect of the Covid19 pandemic has forced companies to face the speed of global change, and investors who identify the businesses altering their ESG inputs, have a better shot at outperforming the index than those relying on ESG scores alone.
“To paraphrase the old Bill Clinton phrase, it’s the companies stupid,” said Parry. “These are the ones allocating all the different forms of capital, whether it’s human, social, natural, financial or intellectual.”
Corporates hoping to ‘optimise’ their ESG scores, without adjusting their business models and purpose, will ultimately lead to poor performance as the market itself adjusts its own measures of success.
“The problem with methodologies and labels is that they can be gamed,” said Parry. “Many investors are surprised when they see tobacco companies score well for ESG.”
Parry explains the next major step for ESG evolution is to standardise reporting from corporates, so investors can see clearly on what a company is doing, not just what it’s reporting.
This needs to happen before there’s a standardisation of reporting for asset managers, he said.
“We need to link ESG to business performance and allocation of capital,” said Parry, adding he is a big supporter of TCFD reporting, a plan to develop voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders.
“The problem now is there’s no standardisation at the corporate level, meaning the data is inconsistent and expensive to produce,” he said.
“If it’s softer at the corporate end, by the time it gets distilled down, manipulated and squirted out at the portfolio end, it’ll become even softer,” Parry said, adding a lack of standard ESG reporting encourages centralised parties in the middle of market to control the data flow and makes it more difficult again for investment professionals.
How to pick ESG winners
But for money managers wanting to take advantage of the clear global trend towards ESG models, Parry suggests looking at those businesses willing to spend time and resources evolving and re-developing their business models.
“Over the short term there can be a dynamic tension between financial returns, social consequences and environmental outcomes, but the best managed enterprises manage that tension well and operate within those three vectors,” said Parry.
“You can stray out of financial prudence for a while but that normally comes back to bite you, and you can push environmental boundaries for only so long before there’s a cost through fines, and similarly with social, you can only push your workers so far before there’s a backlash.”
Ultimately, Parry argues all companies are de facto social enterprises. Like a community or town, they provide benefits to a range of stakeholders.
Last year the Business Roundtable, a lobbying group composed of leading CEOs in the US, released an updated Statement on the Purpose of a Corporation to include their commitment to stakeholders, rather than just shareholders.
“That really introduced the idea of stakeholder capitalism,” said Parry. “Now that we read it back now post-Covid19, it’s a good framework.”