Norwegian manager Skagen, part of the Storebrand group, has issued a view of climate change that outlines how ESG factors are being seen by most investors as a source of competitive advantage, despite dissenters.
This recognition is having an impact not just in active management, but also in the area of ETFs, where Skagen points to compound growth rates in the 2012-17 period, in which ESG was the fastest growing smart beta area, ahead of multi-factor, low volatility, momentum and quality factor-based smart beta strategies – citing data from Bloomberg Intelligence and BofA Merrill Lynch US Equity & US Quant Strategy.
Principles behind the search for sustainability mean that companies should logically seek out operational efficiencies, greater sales and lower costs; all of which contribute to improved shareholder value, Skagen notes. Citing research from Nordea and MSCI, the manager adds that the best ESG rated companies have “significantly higher return on equity and lower share price volatility”.
In turn, this leads to improved share price performance. Skagen refers to Morningstar’s report How can active managers put ESG to work?, published in May 2018, which suggested that by integrating ESG information into a sample of more than 1,000 actively managed global equity portfolios, returns could be improved by up to 30bps and risk reduced by some 15bps per annum in the period 2008-2017.
There is now an increasing schism between what investors are seeking out and climate change politics, Skagen goes on to note. It is a situation in which the US administration has decided to remove itself and the country from the Paris Agreement, but meanwhile asset owners and investors are increasingly looking to embed climate change solutions into their processes.
“It is important to recognise that climate change is an issue for all companies to varying degrees. It therefore forms a key part of our risk assessment alongside other potential threats to a company’s reputation and valuation,” the manager writes.
Last year, 2017, saw the US experience for the first time three Category 4 hurricanes, causing damage valued at more than $200bn, which shaved an estimated 0.8% off Q4 GDP, Skagen says. In Asia, storms and floods affected some 16 million people; in Nepan an estimated 20% of the population were impacted by flooding that destroyed some 80% of crops in the most fertile areas – the figures cited came from National Geographic and DWS, Skagen notes.
Investors need to beware cheap stocks that are so because they involve an inherently unsustainable business model, or could leave investors with a ‘stranded asset’ that has to be written off. In contrast, the Norwegian manager highilghts companies such as Samsung, which is expected to see growing demand for rechargeable batteries used in electric cars, or CMS Energy, a utility in the US electricity and natural gas market, which is seen to be creating value through ‘positive engagement’.
While Skagen predicts increasing demands of public companies to disclose their climate change policies and performance, it also argues that there will be increasing demand on investors to disclose how they embed environmental risk management into the investment process. For example, pension funds and other institutional investors may have a fiduciary duty to factor climate risk into investment decisions – because of the demonstrable link between climate change and financial returns. Such a shift in the approach to fiduciary duty will influence strategies, asset allocation, manager selection and stewardship activities, it says.
For active investors such a situation of change suggests investment opportunities.
As if to underscore the shift in investor attitudes outlined by Skagen, the Irish Dáil (Parliament) voted on 12 July, 2018, to force the country’s sovereign wealth fund, the Ireland Strategic Investment Fund (ISIF) to divest itself of holdings in the fossil fuel sector.
Estimates are that this would affect over €300m worth of investments in some 150 companies globally. The ISIF is a €8.9bn fund, that has a further €3.8bn committed. It is run by Ireland’s National Treasury Management Agency, and has a statutory mandate to invest on a commercial basis to support economic activity and employment in Ireland. The fund was preceded by Ireland’s National Pensions Reserve Fund.
This shift in Irish attitudes reflects those already seen in Norway and other countries such as Singapore. In Norway’s case, its €850bn Government Pension Fund Global – managed by Norges Bank Investment Management, mandated by the country’s Ministry of Finance, but ultimately reflecting the will of Parliament – has previously engaged in exclusions on the basis of its sustainability objectives and use of ESG criteria. The fund owns 1.4% of companies listed globally and 2.4% of those listed in Europe. In 2017, the fund voted in over 11,000 company meetings.