Is ESG still a thing?

Net Zero targets are under attack and investors are being tempted by outperformance from companies in the tobacco and oil & gas sectors. Is there still a compelling investment case for sustainable companies? UK Sustainable Equity portfolio manager Nigel Yates looks at the deeper trends to show why investors should stick with ESG.

A casual observer during Rishi Sunak’s ‘Net Zero’ speech could have seen some irony in him standing at a lectern brandishing the slogan “long-term decisions for a brighter future”. Delaying the much-needed energy transition for future generations feels like a remarkably short-termist measure in the face of the looming environmental crisis.

This disappointing announcement comes hot on the heels of the recent Allocation Round (AR) 5 auction that secured no new offshore wind projects. Investors who have committed to environmental, social and governance (ESG) measures being a key part of their investment process could be forgiven for wondering whether the political will endures to support them.

Is the UK dropping out of the ESG race?

The UK is currently a bit like a 1500m runner that got off to a good start but is fading fast at the crucial time and allowing others to catch up quickly.

The first laps were impressive. We have transitioned from relying on coal for as much as 40% of our electricity generation in 2012 to just 2% in 2021. In 2023, an estimated 50% of UK electricity will be generated by renewable sources thanks to companies such as SSE Plc which is building more offshore wind than any other company in the world.

But we cannot ease our efforts if we are to reach our 2035 goal of 100% renewable electricity generation.

Rising inflation and its impact on living standards has, understandably, become the focus for politicians on both sides of the Atlantic, but it is crucial that they don’t allow short-term factors to distract from long-term needs. The transition to Net Zero will not be easy, but it is vital, and it will take time. Any long-term vision requires focus and determination in order to provide the optimal outcomes.

It is the same with investing. A portfolio of oil & gas, tobacco and coal mining companies will have delivered impressive returns in recent times, and this has led many commentators to ask “is ESG still a thing”?

Look to the benefits, not the costs

It is helpful in these circumstances to turn to the companies we invest in for some reassurance when that element of doubt starts to creep in. Our own extensive ESG analysis shows that there is no let-up in the drive for companies to become more sustainable. This recent statement from General Motors typifies the mood: “General Motors is committed to putting every driver in an electric vehicle on a scale previously unseen and bringing the world to an all-electric future”.

So, are companies reading the tea leaves wrong or the politicians?

While there is no doubt that the transition to a sustainable economy will add costs for corporates, there is also a whole raft of benefits. First and foremost, the revenue growth opportunity from these once-in-a-generation transformational shifts can be enormous. Investing alongside the most innovative companies should bring significant shareholder rewards.

During a recent management meeting with Dunelm, CEO Nick Wilkinson highlighted the point that where there is disruption, there is an opportunity to differentiate. He gave the example of Dunelm’s plans to raise the bar on their cotton to 100% ‘Conscious Choice’ within two years. This will be a market-leading initiative, giving the company a competitive advantage over their peers.

What is also becoming apparent is that businesses with strong ESG principles and practices want to do business with like-minded companies. The Science-Backed Targets initiative (SBTi) – a collaboration between the Carbon Disclosure Project, the United Nations, the World Resources Institute and the World Wildlife Fund – has established a framework for good supply chain and human capital practices that is increasingly being used alongside more traditional factors for awarding contracts. Businesses that are not serious about this are being left behind.

Our recent ESG analysis on Smith & Nephew, the medical technology company, revealed that they demand high levels of sustainability criteria from their tier-1 suppliers in order to award contracts. In turn, Smith & Nephew themselves are also being challenged when they are discussing selling their products to potential purchasers. How a company makes its products these days is as important as what it actually makes.

Not just the environment

However, it is not just environmental matters that are important – companies with a strong culture outperform. According to research by the investment bank Jefferies, the '100 Best Companies to Work For' rankings outperformed the S&P500 by 5.33% annually since 1998, including compound dividend reinvestment.

This is why understanding non-tangible factors of employee engagement, creativity, recognition, autonomy and trust alongside good training, diversity and recruitment practices is crucial to making good long-term investment decisions.

Politicians gamble on short term sentiment shifts, but as long-term investors we have to identify companies with the courage and determination to continuously innovate, despite an ever-changing backdrop. In addition to this, ESG as a competitive advantage is real and we feel it is an important factor in helping us to deliver the best outcome to our clients.