Ryan Smith, head of ESG research at Kames Capital, takes four myths that have grown up around ethical/responsible investing and the reality of the situation for each.
The concept of investing responsibly has been around for more than two decades, but it is only now starting to gain significant traction with the mainstream investment population.
Part of the reason for this is a series of falsehoods which have taken root in the collective conscience of investors, including the belief that responsible investing somehow underperforms compared to alternative investment styles. Another popular one is that there is simply no place for being responsible when it comes to investing.
However, the rise of companies such as Beyond Meat, which are displaying clear signs of success, are helping to change some of these ingrained biases.
Now, companies which do not give any consideration to their responsibilities to everyone beyond their shareholders are increasingly in the spotlight for the wrong reasons.
Nonetheless, many myths still abound about responsible investing which must be dispelled.
Here are four and the reality of the situation behind them.
Myth 1: There is no place for ethics in investment
“Gordon Gekko didn’t do lunch and wasn’t strong on ethics.”
Gordon (as they say) would sell his granny. In contrast, we think there is value in judging a company on the sustainability of its products or services. Industries or companies that perform no social function are inherently unsustainable. They impose costs on society and ultimately, it is highly probable that such activity will simply be regulated out of existence. The sustainability of a company’s products or services is therefore vital to its long-term strategic success. Strategic positioning and vision can be a long-term tailwind or headwind. An unsustainable product (e.g. coal) is a huge strategic headache for any management team, just as a sustainable one should create a tailwind of opportunities.
Myth 2: Thinking sustainably is a downside risk tool only
“It’s all about avoiding controversies and disasters.”
True. Thinking about sustainability, combined with other risk metrics can provide investors with powerful downside protection. However, risk is a backward-looking measure. Thinking sustainably promotes a long-term focus, helps us to avoid short-term distractions and can also be useful for identifying sources of competitive advantage. In the Kames ethical and sustainable strategies, we look for growth stock investment opportunities and typically find that these disruptive, innovative growth companies are more likely to provide responsive investment opportunities and be willing to engage and improve.
Myth 3: Just invest in the best
“There are an increasing number of ESG products being launched, many of which use off-the-shelf third-party ESG ratings to construct their portfolios, or indices.”
In most instances, they adopt a ‘best-in-class’ approach; because the best ESG companies must be the best investment right? Maybe, but in our experience, it’s often a bit more nuanced. ‘Best-in-class stocks’ according to these ratings also tend to be large-cap, well-known and well researched, and hence provide less opportunity for mispricing opportunity to capture alpha. Which is fine, because our focus is on the small and mid-cap space, where we believe better investment opportunities often occur. And to provide our clients with the breadth of negative screens that they seek, our ethical funds are always actively managed. Then, once invested, we take our stewardship responsibilities very seriously; meeting with management, challenging them and if we need to, selling our position.
Myth 4: Profits vs. principles
“Investing responsibly means giving up returns.” Actually, academic studies increasingly disprove this. Empirical evidence supports the premise that thinking carefully about sustainability as part of an investment process can enhance investment returns.
Ultimately, investing is about employing an effective set of tools consistently in order to tip the odds in your favour. Sustainability analysis is one of these tools and it fills a key role in our toolbox, but it’s one which many investors still don’t consciously utilise.
