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The social factor – unfairly underrated

Please see the below article from JP Morgan received yesterday morning:

Environmental, social and governance (ESG) factors have all grown in importance for investors in recent years. But the S in ESG – the social factor – has, until recently, often played second fiddle to environmental considerations.

This neglect is understandable, because what makes up the social factor – how well companies treat their employees, suppliers and customers – is harder to measure than performance on the environment or in governance. Nonetheless, failing to pay heed to the social factor is a mistake because there appears to be some correlation between social performance and share price performance.

The benefits of happy employees

One way to measure this correlation is by looking at Glassdoor, the website where employees anonymously rate employers. Over the past 10 years, the share prices of companies ranked in the top fifth in Glassdoor ratings have outperformed companies ranked in the bottom fifth by over 6%. Glassdoor provides useful quantitative and qualitative evidence, so it can help open the door to engagement with management on social issues. We used Glassdoor, for example, to start a conversation with a management team about issues employees were raising on the platform. This prompted a productive discussion with senior executives about what they thought they could do to address these issues.

Exhibit 1: Glassdoor versus returns

This glassdoor model is a proprietary neural network, which was trained to forecast future financial performance from content in Glassdoor reviews. The model was trained in an expanding window manner, using 5 million reviews from more than 5,000 unique publicly-traded companies, covering the time period from 2008 to present. For more information please refer to footnote.

Another example of how employee satisfaction can contribute to a better company is Rentokil Initial, a British pest-control and hygiene company. The company has a strong culture of listening to employees; this has likely contributed to its high employee retention rate of 85%. Importantly, customer retention is equally high at 86%, supporting the idea that happier employees produce more satisfied customers because the workers tend do their jobs better.

The value of customer service

Treating customers well is another social factor that can also have an impact on company performance, as evidenced by the recent issue of travel refunds thrown up by the pandemic. Customers who booked directly with a hotel or airline found it easier to secure a refund than if they had booked through a third party. We believe that this may translate into an increase in direct bookings, which allows us to try to capture and quantify the differences in customer service by feeding these expected new booking trends into our earnings growth estimates.

Diversity in focus

Treating employees and customers well is one way companies are taking the social factor more seriously. The corporate sector, as a whole, also seems to be paying more attention to social factors. For example, since early 2020 there has been a sharp rise in the number of management mentions of diversity and inclusion in the earnings calls of companies in the MSCI All Country World Index.

Exhibit 2: The importance of social issues in ESG investing

Corporate mentions of “diversity”/“inclusion” in earnings calls

Number of mentions for MSCI ACWI companies, four-quarter moving average

Studies have started to examine the impact diversity on corporate performance. A 2018 study by McKinsey found that companies in the top quartile for gender diversity on executive teams were 21% more likely to outperform on profitability and 27% more likely to have superior value creation, while companies in the top quartile for ethnic/cultural diversity on executive teams were 33% more likely to have industry-leading profitability.

Conclusion

We believe increased corporate focus on social factors will ultimately be good for productivity, economic growth and – in the long term – corporate profits and share prices. We see much for investors to celebrate in the future if the social factor is good for share prices.

Comment

Its an interesting area to improve businesses in the UK. For large corporates like Rentokil Initial, you can see how they can drive change through the business. Is this more challenging for smaller companies?

Keep checking back for our usual market updates, insights and ESG related content.

Andrew Lloyd DipPFS

12/10/2021

Team No Comments

What do the UN Global Compact Principles mean for investors?

Please see the below article that we received from fund managers Quilter Investors yesterday afternoon:

With climate-related risks and environmental challenges seemingly at the forefront of investors’ minds, it’s important that all those involved in the investment industry adopt a broad approach when assessing the major risks facing corporate sustainability today. This should include human rights abuses and forced labour and corruption, as risks to corporate sustainability affect not only shareholders and bondholders but also other stakeholder groups including customers, suppliers and employees.

The UN Global Compact is one of the many tools that can help investors assess threats to sustainable business across the companies in which they invest.

The UN Global Compact – what is it?

Launched in 2000, the UN Global Compact is the world’s largest corporate sustainability initiative aimed at promoting corporate sustainability and encouraging innovative solutions and partnerships through 10 guiding principles.

The UN Global Compact supports companies in responsibly aligning their strategies and operations, in addition to helping them to advance broader societal change, through initiatives such as the UN Sustainable Development Goals.

It also sits alongside the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises, which is another voluntary initiative to support sustainable business.

The UN Global Compact’s principle-based framework is broadly split into four key areas – human rights, labour, environment and anti-corruption – to help guide businesses in their activities in these areas. The framework is derived from numerous international declarations for companies and countries, such as the Universal Declaration of Human Rights and the Rio Declaration on Environment and Development.

The 10 Principles

Human Rights

  • Principle 1: Businesses should support and respect the protection of internationally proclaimed human rights.
  • Principle 2: Businesses should make sure that they are not complicit in human rights abuses.

Labour Standards

  • Principle 3: Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining.
  • Principle 4: Businesses should uphold the elimination of all forms of forced and compulsory labour.
  • Principle 5: Businesses should support the effective abolition of child labour.
  • Principle 6: Businesses should uphold the elimination of discrimination in respect of employment and occupation.

Environment

  • Principle 7: Businesses should support a precautionary approach to environmental challenges.
  • Principle 8: Businesses should undertake initiatives to promote greater environmental responsibility.
  • Principle 9: Businesses should encourage the development and diffusion of environmentally-friendly technologies.

Anti-corruption

  • Principle 10: Businesses should work against corruption in all its forms, including extortion and bribery.

Protection of human rights

Principles one and two relate to the importance of businesses to both support the protection of human rights and ensure that they are not complicit in human rights abuses.

A company that may be deemed to be in violation of the human rights principles could have revenue exposure to jurisdictions or authoritarian governments where human rights abuses are prevalent.

These companies are frequently flagged across emerging markets. For instance, an Indian port infrastructure company was flagged for being in violation of the principles given its financial ties to the Myanmar military.

However, a violation of the principles can be more explicit than this. For example, an Asian engineering and construction company was recently deemed to be non-compliant following a collapsed dam in Laos resulting in fatalities and the displacement of local communities.

Human rights is one of the main areas where investors can see which companies violate the UN Global Compact. It poses a higher risk across sectors such as aerospace and defence where businesses may be involved in the manufacture of controversial weapons.

The UN Global Compact is one of the many tools that can help investors assess threats to sustainable business across the companies in which they invest.

Labour best practice

Principles three, four, five and six are concerned with how sustainable businesses should uphold the effective recognition of the right to collective bargaining, eradicate all forms of forced (including child) labour and eliminate occupational discrimination.

Companies tend to fall foul of these principles less commonly. Following an investigation by Norway’s Council on Ethics, the forced labour risk has been particularly high in the Middle East over recent years. Migrant workers coming from India, Pakistan and Nepal face little hope of paying off the debt they owe to ‘recruitment agencies’ who have charged workers a fee for access to jobs in countries such as Qatar and the UAE.

As a result, there has recently been significant reputational damage to companies allegedly practicing forced labour in the Middle East.

Environmental responsibility

Principles seven, eight and nine provide guidance on how businesses should consider the negative impact of environmental damage, as well as the cost to a company’s reputation should a negative environmental event occur.

The principles also encourage investment in research and development around the long-term benefits of environmentally-friendly technologies.

Companies that are commonly deemed to be in violation of the environmental principles operate across the materials and utilities sectors.

For instance, an Indonesian aluminium business was found to be non-compliant given its interests in a mine that uses riverine tailings disposal (using rivers for mine waste disposal), a practice banned in many countries due to its severe environmental impacts.

Only four mines in the world engage in riverine tailings disposal, and in the case of this business, the mine in question has impacted one of the world’s most bio-diverse regions, Lorentz National Park, a UNESCO World Heritage Site.

Anti-corruption guidance

Principle 10 targets corruption in all forms, including extortion and bribery. The financial services sector is a particularly high-risk area of the market for exposure to corruption, specifically in relation to failings in anti-money laundering procedures.

Money laundering scandals have thrown the spotlight on the major Nordic banks in recent years, particularly those with exposure to the Baltic region, which has been beset by allegations of financial crime.

Our Comments

We have written about these UN Global Compact Principles in the past.

This is one of the key ESG processes that investment managers use to form their ESG screening process in relation to sustainable investments.

These principles are the foundation for investment firms who wish to bring ESG on board within their investments.

The main 2 methods of screening that investment managers use to assess whether or not the companies they choose to invest in are considered compatible with the 10 principles are positive and negative screening. Some firms go above and beyond this and look deeper, some use a combination of both.

Positive Screening is Investment in sectors, companies or projects selected for positive ESG performance in comparison to industry peers. This involves selecting firms that show examples of environmentally friendly and socially responsible business practices. This also includes avoiding companies that do not meet certain ESG performance thresholds.

Negative Screening is the exclusion from a fund or certain sectors or companies involved in activities deemed unacceptable or controversial (e.g. tobacco, arms, gambling etc). This involves avoiding companies that create negative impacts considered incompatible with the UN Global Compact Principles.

Just using these screening methods isn’t enough to ‘change the world’ so to say. It’s important that fund managers engage with the firms they are investing in, to challenge their practices to move them further along the ESG journey and ensure they are adhering to the UN principles.

ESG investing is still a new world, however, since we first started talking about it over a year ago, the ESG landscape has already moved forward, and fast.

We have more of our clients now engaging and starting the discussions around ESG and sustainable investing.

Interestingly, we listened to a compliance update earlier this week from our compliance partners, Paradigm. In this update there was a comment made that the view from MSCI is that they believe that clients will have to opt out of ESG investing in the future, rather than opt in, as they do now.

This supports the view we have had for a while now, that ESG investing will become the new normal.

Andrew Lloyd DipPFS

24th September 2021

Team No Comments

Overcoming the ESG data challenge in China

Please see the below article from JP Morgan received this morning:

China’s ESG reporting is on an improving trend, but investors still need to do their own work and fill in the gaps left by third-party providers to get the full picture.

Data is critical in any investment decision process. For sustainable investing, the requirement goes beyond financial statements – we need specific and comparable ESG data. However, the availability and quality of such data is a major challenge for investors, particularly those investing in emerging markets, including China.

Third-party ESG data providers tend to take a broad-brush approach in emerging markets, and don’t always apply local nuance. In particular, they can lack local language skills and focus on data and information published in English, often leading to significant information gaps. Even more than in developed markets, it is necessary for investors to lead with their own analysis rather than with third-party ESG research. Standards are often better than many foreign investors suspect – but it’s necessary to do the fundamental work and to be selective.

Chinese companies do report information related to ESG, and the trend of ESG reporting is positive. In 2020, 1,021 A-share companies issued ESG reports, representing 27% of all. This number is much higher for bigger companies, with 86% of CSI 300 constituents producing ESG reports in 2020, up from 49% in 2010.1 However, the content of ESG reports in China is highly qualitative. Quantifiable metrics, which are vital for investment analysis, are limited. The transparency of the methodology and the consistency of disclosure are additional concerns for investors. As with third-party providers, overseas investors without local language resources may sometimes struggle to get the full picture as companies listed only on the onshore market tend to report only in Chinese.

Looking at E, S and G data separately, the quality and availability of governance data stands out in relation to the other two, as in other parts of the world. This makes sense as governance has been subject to investor scrutiny for much longer. Measurable and comparable environmental data is also increasingly available, helped by the strengthening of regulatory requirements and commitments made by the authorities. In 2020, China made a surprise pledge prior to COP 26 to reach carbon neutrality before 2060, which should further drive the introduction of policies supporting the transition to a low carbon economy. Social data is more limited, but here too we expect regulation to help.

Exchanges and regulators are major stakeholders that the investment community is looking to for help in uplifting ESG reporting. Hong Kong Exchange is among the exchanges in Asia actively promoting ESG reporting and has introduced mandatory disclosure requirements. In the domestic markets, the China Securities Regulatory Commission (CSRC) also plans to introduce new rules that could require more compulsory reporting of ESG data.

Environmental

Rapid development since China opened up and reformed its economy in 1978 has resulted in economic prosperity but also the environmental challenges we are seeing today. The authorities recognise the need to control pollution and to preserve the environment for a more sustainable economy. This has been underpinned by proactive measures on environmental protection over the past five to six years. The refinement of the Environmental Protection Law stated the responsibilities of companies and their reporting requirements related to matters such as emissions and discharge of certain pollutants. These mandatory reporting regulations help not only the China government but also investors to assess the environmental protection efforts of local companies. While the amount of mandatory environmental disclosure is relatively limited in terms of both breadth and depth, the content is comparable with global standards.

Following the carbon commitments made by China last year, investors are clearly expecting follow-through actions by the central government. Among the expectations for public companies is an uplift in the disclosure requirements of regulators and stock exchanges. Currently, the Shenzhen and Shanghai exchanges do not make environmental disclosure mandatory for all companies. With the global demand for higher standards of climate reporting, which is at the front and centre of environmental reporting, we see a trend towards more exchanges and regulators making certain climate data disclosures compulsory. While not every piece of data is material and relevant to all companies, investors are looking for some critical data points, including Scope 1 and 2 emissions, which are comparable and necessary for measuring the environmental performance achieved by companies. More importantly, China needs greenhouse gas emission data from all companies to track the national roadmap to peak carbon by 2030 and carbon neutral by 2060. On the back of the water crisis that China and many other countries are facing, investors are also looking for greater transparency in water data.

We want accurate static data about environmental footprint, but what we need even more is forward-looking commitments and action plans. We believe that the risks and opportunities related to climate change can have a financially material impact. Today, disclosure on strategies, risks and targets for climate management are uncommon in China. When we engage with companies, we encourage them to align their reporting to an internationally recognised framework, such as the Task Force on Climate-related Financial Disclosures (TCFD). We are looking for expansive adoption of the framework in China.

Social

The Chinese authorities increasingly recognise that robust ESG disclosures and practices are necessary. As a result, they are increasingly implementing regulation, not only on environmental issues, but also related to areas such as labour rights, product safety and diversity – although enforcement still varies by sector and by region.

One element of the motivation for this increased focus is to attract overseas investors to the market. As China’s markets continue to open up, these overseas investors are demanding increasing levels of transparency and positive engagement: a virtuous circle. A major internet company came under scrutiny in January this year following the deaths of two employees – one sudden cardiac death and one suicide. The company is a classic tech stock with a highly driven work culture and long working hours – 9am-9pm, six days a week, is the standard in the sector in China. The company issued its first ESG report in November 2020, which was welcome progress. However, as a result of the increased investor engagement, it has now committed to further improvements in its disclosures, as well as to an action plan on working conditions, including health checks and the establishment of a transparent communication channel for employees to register problems.

Disclosure standards on social issues for some Chinese companies may also be driven to a significant extent by the companies they supply. In sectors including tech and retail, large western companies are closely scrutinised for labour practices in their supply chains, and have therefore pushed for increased transparency on these issues in China. Simply being aware that a local manufacturer forms part of the supply chain for a western organisation with rigorous practices is not a replacement for detailed analysis by investors; however, such an awareness can contribute both reassurance and another potential source of information.

Among domestic investors, too, there is a rising awareness of ESG issues, and although such issues are generally not currently driving investment decisions, we expect them to play more of a role in the future.

Governance

For investors, governance is a foundational precept that underpins public markets. China presents investors with a large economy, in which the state is an active actor. State-owned enterprises (SOEs) offer investors a wide range of options, but are commonly subject to different governance norms and priorities versus privately owned enterprises. This dissonance requires a nuanced approach to mitigate potential risks. In some cases, privately owned onshore enterprises lag their state-owned counterparts around disclosure standards, especially around related party transactions. However SOEs are also not free of potential governance concerns: senior management positions are largely appointed by the Chinese government, with crossover between government officials and SOE boards implicitly raising risk of conflict with investor and creditor interest. The Chinese government has begun to make progress around SOE reform, introducing more professional management, but the scale of the challenge makes progress appear small, albeit determined. We note an increasing number of independent board directors, especially in listed SOEs, where awareness of external rating assessments are more pronounced.

In the private sector, Chinese regulators have been investigating accounting issues and forcing enhanced disclosure, with more public sanctions following evidence of wrongdoing. As a result, the depth of financial disclosure has improved. In response to the negative cost of capital impacts that follow scandal, Chinese family businesses are also showing improvement, through the hiring of professional management or other steps to reduce key employee risk.

We would still like to see increased transparency from both state and privately owned enterprises, including greater clarity around segregation of duties and evidence of awareness of ESG issues. We welcome companies and issuers making greater efforts around investor education, particularly those that make senior executive time available to investors. Overall, we note an improving governance framework evolving in China, with increased investor interaction an area of improvement. The overall standard remains lower than US companies, though improvements on the China side are narrowing the gap.

Conclusion

Overall, we consider ESG data disclosed by Chinese companies still to be insufficient. But this should not rule out sustainable investing in Chinese companies. With the help of on-the-ground fundamental analysis and alternative data, and through active corporate engagement, investment managers can still integrate ESG factors into investment research and create value for their investors.

With a stronger push from regulators, exchanges and investors, we expect Chinese companies to disclose more, better ESG data over time. Higher transparency through the ESG lens would allow investors to better understand the risks and opportunities of companies they invest in. This is critical in driving sustainable investing to the mainstream in China.

1 An Evolving Process: Analysis of China A-share ESG Ratings 2020 by SynTao Green Finance

Our Comment

The above article is interesting as accurate data is one of the key components for our ESG due diligence process.

The article highlights issues with China’s ESG data, but looking at the bigger picture, the rest of the world also has a way to go when it comes to data.

We have to watch out for ‘greenwashing’ which we have written about before, and make sure that the investment providers are doing what they say.

One of the key ways we avoid these data issues is by using multi asset or discretionary fund managers for our ESG offerings.

This makes sure that the investments we recommend are actively managed and that the investments have a strong ESG process built in, which is done by specific and experienced teams of fund managers.

This also helps us to reduce any concentration risk in one market sector and diversify an overall portfolio.

We have an ongoing dialogue with these fund managers and our due diligence is a constant ongoing process which helps us to ensure that the investments we recommend are managed exactly as the fund managers say they are.

As ESG stays under the spotlight and becomes an integral part of investing, the more accurate and reliable data reporting will become. ESG data reporting is in its infancy.

Keep an eye out for more ESG related content from us.

Andrew Lloyd DipPFS

16/08/2021

Team No Comments

Unleashing the power of innovation in emerging markets

Please see the below article from Invesco received over the weekend:

Key takeaways

  1. Innovation is not just about technology
  2. Not a one size fits all approach to finding opportunities
  3. ESG and innovation are both driving change

Innovation in emerging markets is no longer about applying technologies and techniques from developed economies to play catch to the levels of productivity, income and wealth that took centuries to achieve in the United States or Europe.

Instead accelerating innovating is becoming a driver of growth. Our panellists in the ‘Emerging Markets: Innovation Unleashed’ webinar discuss what is underpinning the fast pace of innovation and how it is evolving.

Many emerging markets countries have a strong track record when it comes to innovation. China has overtaken both the United States and Japan in the number of patents being awarded and for many years, Russia has exceeded the number of patents won by Germany and the UK, while India has recently surpassed them as well.

“Innovation has also shaped consumption patterns in Asia and China,” said William Yuen, associate director of investment at Invesco in the Asia Pacific region.

Yuen has put this down to the rapid adoption of the Internet across Asia. Enormous opportunities have opened up for companies wanting to create innovative products for a digital consumer audience.

On the back of this wave small social media platforms, digital payment platforms and entertainment companies have been turned into mega companies.

But the concept of innovation expands much wider than technology and the Internet. Yuen explained companies are not just innovating for digitalisation, rather research and development has evolved and other consumer broad themes have emerged that are driving change and creating investment opportunities. These include premiumisation, experience, urbanisation and wellness.

“A lot of the spending nowadays is no longer just about getting things done or day-to-day survival,” said Yuen. “It is a lot about experiences.”

As consumers demand more, companies are converting existing products into more sophisticated ones to get a higher margin for the return on their businesses.

To find the companies disrupting the market, Bhvatosh Vajpayee, director of equity research at Invesco specialising in emerging market equities, pointed out there are four major ways investors could do this.

First is to look at the scale of the market. For example, India, South East Asia and Latin America have large pools of consumers. Second is to understand how user adoption and developmental gaps can create leapfrog opportunities.

Third is to find localised solutions as countries differ widely on adoption curves and regulations. Lastly is examining local talent and ecosystems. In China, India and Russia local talent pools in science and engineering are particularly strong.

“Every country, every region is very idiosyncratic,” said Vajpayee. “The one lesson that we have learned over the last few years is do not take the template from one country and try to fit it in some other country.”

Innovations were also driving the adoption of ESG principles at the country level and at a sector level.

“These address decarbonisation, clean water and sanitation, climate change mitigation and digitalisation of course,” said Claudia Castro, director of fixed income research in the Invesco global debt team.

For example, as gas demand fades over the next decade, Russia will potentially have a problem as its pipeline capacity becomes redundant, pointed out Castro. Carbon capture and storage facilities have been looked into as a solution to this.

Speaking about the trend of ESG related innovation, Castro said: “We will not see it reversing, but accelerating.” Climate change is a global issue and countries need to recognise it at a local level.

“You have issues of infrastructure damage, displacement of people, food insecurity from disruptions from climate,” said Castro. “It is really important you have local solutions as well.”

This article again highlights what we have been talking about for the past year, ESG innovation is accelerating.

Emerging Markets is a section of the global markets that can offer the potential for real growth. These markets and the developing countries also have an opportunity to be ahead of the curve when it comes to ESG too by each playing to their own strengths, whether this be market size or technology advances.

Emerging Markets is definitely a sector to watch and include in your portfolio for the potential for some good long term returns.

Keep checking back for our usual market updates, insights and ESG related content.

Andrew Lloyd DipPFS

12/07/2021

Team No Comments

Taking stock of the green rush

Please see the below article from Invesco:

Investors are focusing too much on certain sustainability areas, without paying attention to the broader – or even counterproductive – effects. Invesco partnered with The Economist to explore the topic in more depth in their ‘The art of the possible’ series.

Sustainability is the new investment ‘must-have’. It’s estimated that about 20% of investments are badged environmental, social and governance (ESG) of one form or another, and that proportion grows continually. That’s a lot of money: about $20trn and counting.

This has generated a ‘green rush’—what’s now the largest trend in investment. But it isn’t a silver bullet to make money and do good. Although the positive aspects are very real, there are also challenges: how the benefits and costs of such investments are apportioned—indeed, even down to how they are calculated.

There is, for instance, a persistent disparity between where environmental investments are going—largely towards established technologies such as wind and solar—and integral parts of the sustainability puzzle that remain underinvested. A recent survey of large investors globally conducted by The Economist Intelligence Unit found that electricity and heat generation, followed by industry-related investments, represent the lion’s share of sustainable investments. Jason Tu, cofounder and CEO of ESG analytics company MioTech, is seeing a lot of investor interest in “energy generation, transmission or storage, or usage such as electric vehicles”. He also cites farming technology as a particularly hot topic among investors.

Conversely, buildings, transport and agriculture, despite being major sources of greenhouse gases (GHG), have relatively low uptake.

How useful is ESG?

“The starting point for ESG is flawed,” argues Aswath Damodaran, professor of finance at New York University’s Stern School of Business. “We’re trying to substitute company behaviour for laws we should be passing as a society.”

However, others object that pushing this back onto society or the individual is a distraction from the role large corporations play—and sometimes an intentional distraction at that.

“Professor Damodaran is quite wrong to think that anyone in ESG actually thinks voluntary action is a good substitute for good laws,” says Mark Campanale, founder and executive chairman of the Carbon Tracker Initiative. “Quite the opposite. What ESG does however recognise is that the law is a minimum and we should all aspire to higher standards. When governments abrogate their responsibilities—for example by allowing themselves to be lobbied by powerful business interests to block certain standards—then shareholders can step in and take action.” He points to the recent removal of senior executives at Rio Tinto over the mining violation of indigenous Australians’ historical sites as a good example of this.

Technology is playing an increasing role in exposing these sorts of abuses. Mr Tu cites the use of satellite imagery “to see whether there’s any decrease in greeneries at the plantation, or any kind of signs of pollutants around a 30 km radius of a factory”.

This helps investors ensure that their sustainable projects are actually doing good—and choosing projects where they care about their success is exactly how Professor Damodaran suggests approaching green investing. “My advice to investors is pick your dimension of goodness,” he says. “Each of us has something we think is most critical to us, and invest based on that dimension, which means ESG scores are completely useless.”

How well does a company perform on gender diversity, water usage, emissions and so on? Distilling all these factors and more to one ESG number is obviously problematic. Some investors want as low fossil fuel exposure as possible—while others will intentionally be targeting more carbon-intensive companies—to finance a transition from the brown to green economy. ESG scores cannot resolve this; it’s only the starting point.

Mr Campanale takes a different approach: “ESG scoring is neither an investment thesis nor a strategy. What’s more compelling is to find areas that can demonstrate a valuable impact on society, for example investing in the clean energy revolution, or medical technologies. ESG-led investment research strategies that allow you to invest in a spread of high social impact enterprises is really at the heart of responsible finance.”

Pedal to the metal

Such strategies can’t be summed up in one number. A single ESG score—one number encompassing diverse factors—arguably doesn’t tell you much. A fund or stock can have a high ESG score by being in an industry with a low carbon footprint, such as finance, for example, or simply by reporting on lots of metrics that ESG ratings agencies score on. Some large oil companies, for example, score well on transparency, compensating low E with high G.

A positive impact in one area, earning a good ESG score, can also have a negative impact in other areas, which may not be highlighted by some ESG metrics, and so asset owners may be unaware of important consequences of some of their investments. One example of this is the knock-on effect of low-carbon technologies on metal extraction. These technologies use much larger amounts of metal than fossil fuel-based systems, creating an exponentially rising demand. An electric car typically contains 80 kg of copper, four times as much as a petrol-fuelled one. Both wind and solar power plants contain more copper than their fossil fuel equivalents: a typical solar plant contains about 5 kg of copper per kilowatt versus 2 kg per kilowatt for a coal-fired power station, points out economist Frances Coppola.

“It’s surface level ESG, because you think about carbon footprint, you think people who produce gas cars create this huge carbon footprint,” says Professor Damodaran. “If you create electric cars, you’re good. But electric cars create their own costs. And if you start digging into those costs, the question you have to ask is, are we really trading one devil for another?”

Given the reliance of the green energy transition on poorly regulated mining in these regions, does this not risk minimising the S in ESG? And is this not creating wilful blind spots to other forms of environmental degradation? It leads to the accusation, expressed pointedly by charity War on Want, that this green rush threatens a “new form of green colonialism that will continue to sacrifice the people of the global south to maintain our broken economic model”.

That the developed world has used the available resources, then pulled up the ladder to the global south, is echoed by Invesco’s The 21st Century Portfolio report, authored by Paul Jackson, which notes “the developed world has got rich by using up the CO2-absorbing capacity of the atmosphere, leaving little room for the rest of the world to develop”.

For Professor Damodaran, addressing the issue cannot rest at the door of the corporation: “Much of the ESG literature starts with an almost perfunctory dismissal of [founder of monetarism] Milton Friedman’s thesis that companies should focus on delivering profits and value to their shareholders, rather than play the role of social policymakers,” he says.

This article highlights one of our key points about ESG which we have repeatedly stated over the past year throughout our ESG related content, that ESG is a journey.

It isn’t a ‘one size fits all solution’, its about aspiring to do better.

As the ESG trend continues to grow, fund managers and investors alike, are learning more and more every day. Companies are having to adapt to the increasing ESG standards that are set.

Whilst a company may only score well on one aspect of ESG, it may be lacking in others, however over the next few years, ESG isn’t going away so it’s important to remember that every company will have a starting point and should continue on their journeys to improve in all aspects. If they don’t, they will be held accountable by their clients and fall behind the rest who will be actively trying to improve their ESG ratings.

Keep checking back for our usual market updates, insights and ESG related content.

Andrew Lloyd DipPFS

23/06/2021

Team No Comments

Giving Voice to The Quiet Revolution: Asset Management, The Environment and Popular Perceptions

Please see the below piece from Invesco received late yesterday afternoon:

Key Points

  1. As demonstrated by environmental protests against asset managers accused of “funding destruction”, the investment industry remains broadly perceived as uninterested in the existential challenges facing humanity.
  2. Contrary to such perceptions, asset managers have taken a lead in promoting sustainable policies and practices – especially through active ownership of and engagement with the companies in which they invest.
  3. It is vital that this “quiet revolution”, as the University of Cambridge has described it, builds wider recognition and that stakeholders of all kinds appreciate that their interests may be aligned with those of asset managers.

More than a decade on from the global financial crisis, the investment industry is still popularly perceived as a self-serving entity with little or no regard for the greater good. Before the COVID-19 pandemic curtailed mass gatherings, environmental activists’ demonstrations – including several against financial services companies said to have “funded destruction” – provided a clear reminder of how negatively this sphere is viewed by many of those outside it.

Former President of Ireland Mary Robinson, now a UN Special Envoy on El Niño and Climate, even suggested that Extinction Rebellion protesters should specifically target asset management firms. This tactic, she said, would lessen the likelihood of the group alienating members of the public.

Such a sentiment underscores the degree to which asset managers, routinely cast as essential cogs in the machinery of “big business”, are deemed complicit in many of the world’s ills. Yet it also implies that they can bring about positive change; and what appears to be consistently overlooked, at least in the mainstream narrative, is that this is exactly what they are doing.

The first decade of the 21st century exposed the limits of capitalism as we long knew it. There is no disputing this, just as there is no disputing that the resulting backlash against sections of the investment industry was deserved. Yet capitalism always has been and still is a work in progress: it has evolved substantively in seeking to avoid the errors of the past, and asset managers have been at the heart of the unfolding shift.

This is because responsibility, sustainability and long-term thinking are becoming norms for the sector. Asset managers are spearheading what the University of Cambridge has described as a “quiet revolution”, and the reality – unlikely though it might seem to some critics – is that many investment professionals have a deep and even long-held commitment to the future of the planet and its inhabitants.

A passion for the environment is not some sort of obligatory extension of work for such individuals. Quite the opposite: work is a potent augmentation of their passion for the environment. This should be acknowledged far beyond the industry – not because asset managers yearn to be loved or are tired of being harangued by climate campaigners but because stakeholders of every kind need to comprehend that there is a massively important alignment of interests here.

Contrary to widespread assumptions, asset managers are not fiercely determined to thwart efforts to make the world a better place. In fact, many want to be central to such endeavours. In this paper, drawing both on our own experiences and on insights from leading researchers, we seek to show that the quiet revolution is well under way; we attempt to highlight a more “human” side to the people behind it; and we try to explain why it merits much broader recognition.

Along with the investment industry in general, asset managers have attracted considerable criticism in recent years. With past sins still largely informing mainstream opinion, the scorn of the broader public – from environmental protesters to media commentators to the proverbial man and woman in the street – seemingly remains as strong as ever. Overturning such firmly entrenched disdain and distrust will not be straightforward. The investment industry as a whole has often made headlines for the wrong reasons, and the popular realisation that it has a much more admirable side will unquestionably take time to emerge.

The quiet revolution has been under way for several years. Maybe now is the time to make more noise about it – not for the sake of asset managers’ self-esteem, not because we demand due recognition, but because how we and our efforts are regarded and understood is likely to determine our effectiveness in helping plot a truly responsible course for the future.

This article is another indicator of the direction of travel within the industry. ‘Ethical’ and ‘Socially Responsible’ investment themes have always been there in the background, but over the past two years and especially since the onset of the pandemic, it no longer seems to be in the background.

Almost every fund manager now has to take into account ESG factors within their investments and portfolios whether they are doing so because they believe its right or because they now see that they have to in order to keep up, either way, its still a good push in the right direction.

People are waking up to making the world a better place, be it via social issues or climate issues.

Investors now seem to take comfort in the fact that they can help and ‘do their bit’ to help make the world a better place.

Andrew Lloyd DipPFS

17/06/2021

Team No Comments

Royal London: ‘How we’re helping tackle the climate crisis’

Please see the below article from Royal London received over the weekend:

The majority of our assets just over 90% – are invested with Royal London Asset Management (RLAM), and their responsible investment team is doing great work to help drive the move to a low carbon economy and leading the way on the Just Transition.

What is the Just Transition?

Just Transition ensures that social issues are taken into account in moving to a low carbon economy. Rapid climate action that limits global warming to below 1.5ºC prevents the worst human and economic costs of climate change. A Just Transition ensures this climate action also supports an inclusive economy and avoids exacerbating existing injustices or creating new ones.

We care about Just Transition in the industry, because without adequate considerations of the social impacts of accelerating the path to Net Zero, there is a risk that people will not be willing to make the hard choices we need in order to limit the impacts of climate change. This can lead to policy delays and uncertainty. Companies that acknowledge this challenge and plan for a Just Transition, will be more likely to deliver on their commitment to low-carbon growth. We believe energy utility companies should develop formal Just Transition strategies to manage social risk and ensure they continue to deliver good value for society and their investors.

A just transition for Scottish and Southern Energy (SSE)

SSE is an energy utility company that helps produce and distribute gas and electricity to our homes. It is one of the largest producers of wind power in the UK and has committed to become ‘net zero by 2050’ – which means that by 2050 the amount of greenhouse gas emissions produced by SSE will be equal to the amount it removes from the atmosphere.

RLAM’s responsible investment team has been champions of SSE’s strategy to move to wind power and reduce its reliance on coal and gas, which will have a big benefit for our climate. However, they’ve also been talking to SSE about the Just Transition – what the company is doing to ensure that its transition to lower carbon energy also considers any negative social consequences like significant job losses or making energy bills unaffordable. Solving the climate crisis is not straightforward, and the responsible investment team is asking companies to take a more holistic view and look at both the social and environmental consequences of taking action.

Please continue to check back for a range of blog content, from ESG focused pieces like this one to market updates and insights from a variety of the worlds’ leading investment houses.

Andrew Lloyd DipPFS

07/06/2021

Team No Comments

Electric vehicle adoption relies on investment into infrastructure

Please see the below article from Tribe Impact Capital received yesterday afternoon:

Driven by changing consumer behaviours, increasing choice and affordability, recent net-zero pledges by governments and the desire to ‘Build Back Better’ after the pandemic, the demand for electric vehicles (EVs) continues to grow. According to Bloomberg New Energy Finance, EV sales will rise to nearly 60% of the global auto market by 2040, a huge shift from almost 0% in 2010. With consumer consciousness on the rise and market forces gaining momentum, EVs are quickly becoming the future of the automotive industry and a target market for investors.

However, before any serious adoption of EVs can take place there needs to be significant investment in the infrastructure that supports EVs. This includes the charging points but also the entire electricity grid.

EV charging points

The issue of sufficient access to electric charging points for those who don’t have the access to off-street parking needs to be addressed if there is to be widespread adoption of EVs. A report by the European Automobiles Manufacturers association in October 2020 showed that while EV sales in Europe had increased over 100% during the last 3 years, the number of public charging points had grown by just 58%. Similarly, in the UK, all-electric cars went from 1.6% of the market in 2019 to 6.6% in 2020. The report found the UK is likely to need around 400,000 public charge points by 2030, a considerable increase from the existing 35,000.  The current installation rate of 7000 a year is not enough to meet requirements if the UK is to be ready for the ban on sales of cars with an internal combustion engine in 2035. Installation will need to occur five times faster at a cost of between £5 billion and £10 billion by 2030.

Providing enough residential on-street charge points and charging facilities in public spaces will be critical in high-density residential areas where it’s simply not feasible for every property to have cables running from their electricity supply to their vehicle. National Grid points out that with 20 million EVs on the road there will be at least 8.6 million vehicles that will not have the facilities for charging at home.

This is not just an issue for the UK though. The quantity of public chargers is growing the fastest in China, followed by Europe and then the US. China still has the largest network of public chargers. They had more than 500,000 chargers by 2019, accounting for more than 50% of the global total. However, a large number of chargers does not mean an ideal vehicle-to-charger ratio. While China’s passenger electric vehicle-to-public charger ratio (8.5 to 1) is lower than that of the United States (17 to 1), some European countries have even lower EV to public charger ratios (France: 7 to 1; Germany: 5 to 1; and the Netherlands: 4 to 1).

Electricity demand

The second major infrastructure to consider is the supply and distribution of the electricity itself. At their current trajectory EVs are set to double domestic electricity demand. At scale, this would present significant challenges to the distribution network. As we see increased adoption of intermittent renewable energy sources we might start seeing large imbalances between supply and demand in terms of power provision. Not only do we need to build out our existing network capacity and reinforcement we need to get better at managing system stability, energy storage and smart charging. 

What does this mean for investors?

The UK government recognises that widespread adoption of EVs is key to achieving their climate goals with the Chancellor announcing in the government’s spring Budget that £500 million will be invested into a rollout for charging hubs. Whilst this investment will help play a role in piecing together the UK’s fragmented infrastructure and easing the pressure on public sector organisations, more capital for wider and faster deployment of a national charging grid is needed. Many supermarkets are now providing electric charging hubs in their car parks in partnership with others. Many supermarkets in the UK have increased their commitments to sustainability and investors are now starting to look at these companies with renewed interest.

Despite the noise and potential in companies like Tesla, Nio and others, for example, Volkswagen, the EV story also represents plenty of opportunities for investors outside the main car manufacturing segments. Charging points are the next logical step but looking at the sector more broadly there are opportunities in smart metering, battery storage, network improvement, smart cities and core technology (for example semiconductors, and artificial intelligence). The shift to EVs will have major implications not just for the way we travel, but the way we build cities and our consumption of electricity itself. With this in mind, the opportunities for investors further increase.

For example, smart meters (electronic devices that accurately monitor electricity use and send this information to the user or the utility company to effectively manage and optimise energy consumption) are key to driving efficiency in energy usage. They can potentially manage the demand on the grid by notifying consumers of the best time to charge, helping reduce consumer costs. Renewable electricity providers are also starting to provide ‘free’ tariffs for EV owners to manage potential cost implications.

The market for smart meters is growing rapidly and in 2019 US electric companies installed over 98 million smart electric meters, covering more than 70% of US households. The global smart meter market size was valued at $21.13 billion in 2019 and is projected to reach $39.20 billion by 2027, an annualised growth rate of 9%. Utility companies are keen to install meters, they enhance the energy grid’s resilience and operations and help provide visibility into the system operations, thereby avoiding outages.

Similarly, the battery storage market is set to double over the next 5 years. Batteries provide a critical role in our future power systems as they provide the flexibility required by the grid to support the variability of power generation from renewables when environmental conditions are not favourable for power generation. Not only is demand going up, but input costs are coming down. By 2030, total installed costs could fall between 50% and 60% (and battery cell costs by even more), driven by optimisation of manufacturing facilities, combined with better combinations and reduced use of materials. Battery lifetimes and performance will also keep improving, helping to reduce the cost of servicing. Improved batteries will help support the grid by providing flexibility to store energy and release it when demand for EV charging is high.

With all investment opportunities, however, comes risk. The widespread adoption of electric vehicles comes with some stings in the tail, most notably the use of rare earth and precious metals used in the battery and technology embedded in the vehicles themselves. Complex supply chains, sometimes in politically unstable geographies and/or where the rule of human rights may be less robust, increase the risk of human rights abuses, as well as environmental degradation. As investors it is essential to be aware of and manage these risks. Doing so can uncover solution opportunities, for example, in businesses dedicated to the recycling of these rare earth minerals at end of life in many rechargeable battery applications.

Global governments have built widespread adoption of EVs into their carbon neutral plans which will have major implications not just for the way we travel but the way we build cities and our consumption of electricity itself. For investors, it’s important to look at the bigger picture and recognise that the opportunity set is much wider than a few automobile names.

This is an interesting look at the investment opportunities within the electric vehicle landscape looking beyond just investing in the vehicles themselves or the big EV companies (i.e. Tesla), but looking at the infrastructure around this, charging points, smart metres, clean energy etc.

The pandemic not only changed the world itself, but how people think about the world, the environment and what the future will look like.

This is a growing investment space and another key indicator that ESG has gone mainstream.

Andrew Lloyd DipPFS

04/06/2021

Team No Comments

The Implications of Carbon Pricing Initiatives for Investors

Please see the below article received from JP Morgan this morning:

‘In our view regulatory interventions will increase, and these interventions will underpin carbon prices not only in Europe, but also globally.’ – Vincent Juvyns

European policymakers have been focused on tackling climate change for many years. The launch of the European Union’s (EU’s) Emission Trading System (ETS) in 2005, the first carbon market in the world, has been the cornerstone of the bloc’s policy efforts. Since then, the ETS has been upgraded several times to reflect the EU’s growing climate ambitions and changes are now accelerating further since the EU has agreed to reduce its greenhouse gas (GHG) emissions by at least 55% by 2030. These regulatory initiatives at least partly explain why prices for CO2 emissions allowances in Europe have recently reached an all-time high of 56 euros per tonne of carbon dioxide equivalent (tCO2e).

The EU’s example is being increasingly copied, with several individual countries launching their own emission trading systems. At present, global carbon prices remain well below those seen in Europe. If they fail to move in line with what the EU deem to be acceptable, the subject of carbon taxes at the EU border will be an increasing reality. This is why we believe investors should be aware of the impact of higher carbon prices on their portfolio.

What drives carbon prices? Europe case study

There are two main types of carbon pricing mechanisms: a carbon tax, which is the most direct way to set a price on carbon, but which doesn’t set a pre-defined emission reduction target; and an emissions trading system, which caps the total level of GHG emissions, but doesn’t set a pre-defined price.

The EU chose the second approach when it created its ETS in 2005. The EU’s ETS is the world’s first and also the largest emissions trading system as it covers 45% of the EU’s GHG emissions produced by three sectors within the European Economic Area: electricity/heat generation, energy-intensive industry, and commercial aviation.

Companies in these sectors are allocated a free emissions allowance. Those with lower emissions than their allowance can sell their “unrequired” emissions to other companies in the sector (Exhibit 1). The balance between supply and demand for emissions creates a market price.

The EU can influence supply and demand dynamics to raise the carbon price in three ways: by reducing the emissions cap; by increasing the industries subject to the scheme; and/or by reducing the allocation that is deemed free.

In its recent directive, the EU decided that the aggregate emissions cap will fall by 2.2% per year from 2021 onwards (vs. 1.74% before). The EU is still deciding whether to include new sectors, such as transportation and buildings. The percentage of free emissions allowances, which had already fallen from 80% in 2005 to 43% in 2020, is to gradually decrease to 30%.

As a result, while some of the recent surge in the carbon price may reflect strong demand for emissions allowances as firms meet rising demand, there is a structural underpinning to higher carbon prices from regulatory interventions.

The balancing act between internal drive and external competition

EU authorities are mindful of the delicate balancing act they face between meeting domestic climate ambitions while at the same time not damaging corporate profitability and competitiveness compared to international competitors that are not subject to similar regulatory standards. Encouraging international peers to keep up with the EU’s efforts is bearing some fruit: other regions are beginning to launch their own emissions trading schemes and 25% of global GHG emissions are now covered by carbon pricing initiatives compared to just 5% in 2005 (Exhibit 2). However, the carbon price in these regions is much lower than in Europe (Exhibit 3).

Coverage of global emissions trading schemes and the impact on carbon prices

Exhibit 2: Global emissions covered by carbon pricing initiatives

% of global greenhouse gas emissions

Exhibit 3: Emissions trading system prices

USD per tonnes of CO2 equivalent

Carbon prices internationally are not only lower than those in the EU, they are also below those required to meet the global climate objective of reaching net zero emissions by 2050 according to many climate scientists and policymakers. Although the estimate is wide, a range of between USD 40 and USD 80 per tCO2e is often argued as necessary to limit global warming to less than 2°C.

Carbon prices will no doubt be a key topic of conversation when global leaders convene at COP26 in November. If the EU, China and the US cannot agree on a path towards a common carbon price, the EU may need to find a short-term solution to ensure that its climate efforts do not disadvantage European businesses.

One solution that appears to be growing in appeal is a carbon border adjustment mechanism (CBAM). This import tariff would be designed to ensure that the environmental footprint of a product is priced the same whether it is manufactured locally or imported. The CBAM is one of the key measures discussed as part of the EU’s Green Deal. The proceeds of the tax would form part of the EU’s budget, which would be used to finance the EU’s recovery and green transition.

At this stage the CBAM is a threat to international peers, but the credibility of that threat has been strengthened given the legislation that would be required has been approved by the European Parliament. It is now up to the European Commission to decide whether to use it.

Investment implications

In our view regulatory interventions will increase, and these interventions will underpin carbon prices not only in Europe, but also globally. The result will be an increase in the cost base of companies in a growing number of sectors.

One of the key investment implications is that increased business costs may serve to raise consumer prices, adding to growing inflationary pressures from loose monetary and fiscal policies. If firms are unable to pass on higher costs the higher carbon prices may dent profitability.

If the CBAM is activated, companies that export a lot of their carbon-intensive products to the EU may suffer from higher carbon prices, even if their home country does fairly little in terms of carbon regulation. The price of carbon is therefore a risk that needs to be monitored.

On top of traditional financial analysis, investors may look to evaluate non-financial parameters, such as the carbon intensity of companies, as we believe that minimising the carbon intensity of a portfolio should help improve its risk/return profile over the long term. This is what we have already observed over the last couple of years when comparing the MSCI World index with the MSCI World Climate Change CTB Select, a Climate Transition Benchmark under the EU Benchmark Regulation, which reweights securities based upon the opportunities and risks associated with climate transition risks.

Indeed, the MSCI World Climate Change CTB Select Index has a Weighted Average Carbon Intensity (which represents the number of metric tonnes CO2 equivalent emissions per USD million enterprise value including cash) that is almost 40% lower than the MSCI World Index, while it has also outperformed the latter by 150 basis points since its inception in November 2013, and has a better Sharpe ratio over the last three and five years.

With global carbon prices set to increase further in the future, minimising the GHG emissions of a portfolio should not only contribute to the fight against global warming, but it should also lead to better risk-adjusted returns in the long run.

Please continue to check back for a range of blog content, from ESG focused pieces like this one to market updates and insights from a variety of the worlds’ leading investment houses.

Andrew Lloyd

01/06/2021

Team No Comments

Sustainable fashion: Why it matters, and how to identify the winners

Please see the below article from JP Morgan received yesterday, 26/04/2021:

The concept of sustainability is rapidly rising up the agenda within the fashion industry. Yet while consumers are increasingly interested in sustainable fashion, they are not willing to pay a premium for it. Still, sustainability can be a competitive advantage. We have seen companies delivering a sustainable message, but identifying the true leaders from the potential greenwashing takes research.

Consumers care about sustainabilty, but not at any price

As the global population grows, the negative environmental impacts of our demand for fashion are becoming more apparent. The industry is responsible for 10% of global carbon emissions and 20% of global wastewater, as well as producing significant amounts of waste. The equivalent of one garbage truck of textiles is dumped in landfill or burned every second.

75% of consumers view sustainability as ‘extremely’ or ‘very important’ in their fashion purchasing decision. And over 50% of consumers would switch for a brand that acts in a more environmentally and socially friendly way. But in practice, are consumers really willing to pay? Not yet, it seems. Only 7% of consumers say sustainability is the most important factor in their decision making.

Exhibit 1: Consumers care about sustainabilty, but not at any price – most important factors in decision making

Consumers continue to rate ‘high quality’ and ‘good value for money’ as the most important factors in their decisions. This is backed up by our engagements with fashion companies, who claim that consumers are not willing to pay a premium for sustainability, although at the same price point they would choose the more sustainable offering.

To us, this signals that consumers have a preference for sustainability and it can be a competitive advantage for retailers. But companies need to see it as a way to maintain or grow their market share rather than a way to increase prices. Sustainable leaders should be investing in innovation and scale for sustainable solutions to bring prices down and maintain their brand position.

Case study 1

Re:NewCell: Driving down costs for sustainability in fashion

Re:NewCell is a Swedish company driving down the costs of sustainable materials through innovation. The company has developed and patented Circulose, a high quality material made from recycled clothes. We expect Circulose – which has already been adopted by the likes of H&M and Levi’s – to see increasing uptake within the fashion industry, helping to lower the cost of sustainable materials and improve the industry’s environmental footprint.

Case study 2

Adidas: Leading the charge on sustainability

Adidas, the well-known sportswear brand, is at the forefront of sustainability within the fashion industry. The company particularly stands out on circularity, which is embedded in its strategic priorities: by 2024, Adidas has committed to replace virgin polyester with recycled polyester. The company already partners with the environmental organisation Parley for the Oceans to use recycled polyester made out of plastic collected from the coastline. All of Adidas’s cotton is sustainably sourced via the Better Cotton Initiative, earning Adidas the top spot in a 2020 independent ranking on sustainable cotton sourcing. Adidas has committed to reducing greenhouse emissions across its entire value chain by 30% between 2017 and 2030, and then achieving climate neutrality by 2050. As a further validation of Adidas’s sustainability efforts, these goals were submitted for external verification by the Science Based Target initiative in February 2020.

Sources: Adidas and the Sustainable Cotton Ranking 2020 (77 companies).

The companies above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.

Distinguishing the real from the fake

The fashion industry is highly fragmented, and sustainability standards are still in their infancy. More and more companies are reporting on both their environmental and social impacts. But with different companies focusing on different disclosures, metrics and measurement methodologies, how can we identify the best? For us, fundamental research and company engagement are key, allowing us to assess whether fashion brands are paying lip service to sustainability or whether they are truly committed to it.

What do we look for in a sustainable fashion leader? 

  • Has the company signed up to measurable targets to reduce its negative environmental footprint?
  • Is the company abiding by external certifications to demonstrate the sustainability of its products?
  • Is the company accurately measuring and reporting its entire carbon footprint?

The last of these requires particular research focus as only about 5% of a fashion retailer’s carbon footprint comes directly from its own operations (scope 1 emissions) or indirectly from generating the energy used by the company (scope 2). The vast majority of carbon emissions occur in the company’s value chain (scope 3). This includes production, processing and transportation of fibres and fabrics, transportation of the end product to its final destination, and emissions related to use, care and disposal. Unsurprisingly, this complexity means that emissions are currently underreported, with many companies only reporting on transportation of the end product. Fundamental research is therefore key to understand the supply chain picture and determine what companies are really doing to reduce their total emissions.

Conclusion

While price sensitivity remains key for consumers in the fashion industry, evidence points to sustainability becoming more important in purchasing decisions and ultimately to long-term brand value. This implies a material opportunity for sustainable leaders to stand out while unsustainable fashion brands lose out. Yet the potential for greenwashing is rife in the industry, making it difficult to distinguish between leaders and laggards in the transition to sustainable fashion. Company research and engagement is key.

Our Comments

This is another example of sustainability and ESG themes filtering down to everyday life.

The fashion industry, particularly the problematic ‘fast fashion’ companies seem to hit the headlines on a regular basis for all sorts of issues, from waste to poor working conditions so the sustainability of the fashion industry is starting to be questioned more often.

With fund managers now also becoming increasingly more concerned with ESG and sustainability issues, the fashion industry will have to also adapt to these changes in the way consumers and investors are thinking and what it is they are looking for when investing or purchasing their products.

Shopping for items such as clothes became pretty much an online only occurrence for a large proportion of the past 13 months, I have myself noticed that sustainability is being used a selling point, whether it be statements on the companies website or even noted in the products description. Some companies plant a tree for every item of clothing purchased.

As this article highlights, a lot of people would consider switching to more environmentally and socially friendly brands, but they may not be willing to pay an extra premium for it. Personally, I don’t think it will be long until paying extra won’t be an issue, as the world changes and now has ESG principles under a microscope, these companies will have to adapt to remain competitive in the marketplace.

From a personal experience perspective, I recently purchased an item of clothing having no idea it was part of a ‘sustainable’ line until I was checking the label for the washing instructions only to find out that the item was made out of 100% recycled plastic bottles and textile waste that had been processed and melted down into new fibres in an effort to save water, energy and reduce greenhouses gases.

The item was no more expensive than a ‘non sustainable’ item and the quality was probably better than products that use ‘virgin’ or non-recycled materials.

As consumers, if you don’t have to compromise on cost or quality, then why wouldn’t you choose more sustainable options?

Andrew Lloyd

27/04/2021