over 3 years ago • 12 mins
Jessica Alsford, global head of sustainability research at investment bank Morgan Stanley, joined us to explain why investing with environmental, social, and governance (ESG) themes in mind is more about than just making your investments morally palatable.
For Jessica, ESG is all about insulating your money from activities that could prove to be harmful to your investment returns over time. She also had a good response to the question of whether you should avoid giving your money to companies you don’t like – or actively invest in order to use your clout as a shareholder to effect change. For Jessica, it all depends whether the sector in question has the capacity to change its ways or whether its entire business model is in danger.
Here’s a transcript of the interview. Hit 🎧 in the app to listen.
Andrew Rummer: Hi Jessica. To start with, can we just clarify the various terms that people throw around when talking about investing with a purpose greater than just making money. Is it “ethical investing”. Or should we call it “ESG”? And what’s the difference?
Jessica Alsford: ESG generally is more of an umbrella term and then within ESG or within sustainable investing, you can get lots of different approaches. And one of those approaches is ethical investing, which really is about investing in alignment with your values. So it might be deciding to not invest in certain sectors, for example. But there are then other approaches like thematic investing, where you might pick a theme like climate change and simply invest in companies that are selling products that help with climate change – or help to stop climate change. So electric vehicles, renewables, for example. We also have what we call broad ESG integration, whereby you can invest in anything – but you need to be taking into account environmental, social, and governance risks and opportunities and how they can impact the value of the companies. So it is quite a complex landscape and there are lots of different ways of really approaching this space.
Andrew: To keep things big picture, why should anyone consider these ethical aspects when investing their money? Aren’t most investors mainly focused on simply maximizing their financial returns?
Jess: So I think there's a number of reasons. It can be quite personal, so sometimes it is about alignment with values and so wanting to ensure you’re allocating capital towards companies that you have a similar belief system in, for example. But I think, putting that to one side for the moment, it’s very important to think about ESG as not being an add-on, additional screen, but actually it's really getting to the key dynamics and the key fundamentals of how companies create value. So if you take, for example, the issue of climate change. There's a real risk that carbon prices are introduced in more countries and those countries that already have a carbon price are going to increase that cost of carbon over time – as a mechanism for trying to reduce carbon emissions and incentivize investment in carbon technologies. Now, if you're investing in companies with high carbon emissions, the introduction of a high carbon tax is going to change the financials of those companies. And suddenly profitability could be a lot lower. Cash flows are not going to be so strong. So you can really see how ESG actually does impact value. It's not just sort of a values-alignment approach to investing.
Andrew: Whenever I think about ESG investing, I immediately come up against this question of, do I just want to stop my money flowing into shares of companies I find objectionable – or do I want to deliberately buy shares of those companies in order to use my clout as a shareholder to push their policies in a direction that I want? Could you walk us through this whole dilemma?
Jess: There are a number of things to consider. I think, first of all, is it an industry where there is a possible path to becoming more sustainable? So fossil fuels and energy being a good example of that. If you are a utility company with coal power generation, there's a possibility for you to move towards greener options by investing in wind and in solar. Other industries, maybe the product doesn't have such a clear alternative that is more sustainable. So I think that is one of the decisions that needs to be made when you're thinking about whether you are investing to drive change or simply deciding to stay away from investing in those sectors and those companies. I think the other approach that we see as well is that those two are not mutually exclusive. Actually, one can then lead to another. So you could decide to invest in a company to try to engage and drive positive change. But what if the company doesn't respond in the way that you want them to? How long do you keep that engagement going for? How much do you invest, over time, if you still aren't seeing that positive change that you're looking for? And so I think engagement with companies is a really powerful tool. But arguably, you still need, at the end of it, to have the position that you may divest, you may remove your capital – that sort of final power to really be able to show that that is the transition that you want. And if the company is not going to move in that direction, then actually I decided to go and move my capital elsewhere. So they do sound contradictory and they are different approaches. I think actually you can use them together in quite a successful way.
Kieron Banerji (host): This next bit gets a bit technical, with Andrew and Jessica talking about the phenomenon of factor investing. This is where an investor uses broad criteria to decide which companies to allocate money to: so they might follow the value factor and only invest in companies with a price-to-earnings valuation below a certain threshold, or they might follow the growth factor and only buy stocks of companies that are forecast to grow their sales or profits strongly. Here’s Andrew again…
Andrew: So, Jess, when you’re discussing investments with clients, are they generally approaching ESG as an extra screen before buying a stock or treating ESG as a factor? To put it another way: are they saying I really want to get into, say, airline stocks at the moment because I think they’re super cheap and then starting to screen by ESG metrics. Or, alternatively, do they approach buying into ESG almost like buying into a factor like value or growth?
Jess: This really comes back to the initial points in terms of how you define sustainability and ESG. Where the sustainability analysis comes in the investment process is going to vary depending on what you are trying to achieve. So certainly we have some investors that we speak to where – the airlines example is a good one – where they want to invest in the sector, but they're just thinking about ESG just as part of a number of different factors that could possibly be relevant for that investment decision. At the same time, you also get investors where their whole purpose for investing is sustainability. And so much earlier on in the process, they're going to be deciding actually, is this a company or is this a sector which meets our criteria for becoming an ESG investment? And so we're narrowing down our investment universe using ESG and sustainability criteria, and then we're applying our traditional investment process. But the third area, which you referred to actually as well, is becoming much more important and is appealing to more investors. And that's this idea of ESG as a factor. What we have seen is that asset flows and asset prices our being impacted in certain areas of ESG. And the main area – I feel a little bit like repeating myself but it is important and it's the main area of where you do see the impact – and that's around the climate change in the carbon. So for those companies that are either very heavy on green revenues, like the renewable space, you have seen a rerating of those companies. You have seen a lot of demand and assets flowing towards those types of investment opportunities. At the same time, some of the more carbon intensive businesses and industries have suffered with the opposite effect. And it would be interesting to see if, over the coming years, do more areas of ESG also follow suit and you see asset base and asset prices being impacted in the same way. But for other topics, whether it is sustainable consumption or biodiversity or diversity and inclusion – there's such a broad range of topics that come under the ESG umbrella. And we’re only just starting to see ESG as a factor, but I'm sure that will become more evident over time.
Andrew: It seems that it's impossible to have a conversation about this space without talking about the scores that various industry bodies publish to measure how well companies are hitting different ESG metrics. When you look at these lists of companies that score well then, frankly, some of them raise eyebrows. And some companies – like Tesla – can score incredibly highly on some lists and incredibly badly on others, depending on whether they’re focusing on, say, environmental issues or governance issues. How do you approach this whole issue of scoring?
Jess: Looking at issues of sustainability requires analyzing huge amounts of different types of information, and it's such a broad area. So I think where scores are really helpful is it's a really good starting point for identifying where potentially the red flags are where, as an investor, you might want to do a little bit more detailed analysis, speak to the company to really understand what's going on. I think also it's going beyond the headline school to dig down into some of the subcategories. Typically scores contain a huge amount of different types of topics and different information all condensed down into a single number. So there’s going to be a lot of richness of information and data underlying the scores. I'd say as well that, typically, there are a wide variety of different scores available, but typically scores are ranking companies relative to the sector peers. So I think as an investor, you need to take it, first of all, a decision about whether there are certain sectors, certain types of products that you do or don't want to be investing in. But then when you're looking within a sector, those scores can be useful as a starting point to think about how companies are performing – not just in terms of the products that they're selling and the impact that the products have on the environment, on society, but how the business is being run. Do they have a diverse board? Are they trying to improve their own energy efficiency? Do they have a level high employee engagement score? And that's why I think scores can be used quite effectively.
Andrew: OK, one final question, and I’d like to get a little bit nerdy. If the goal of ESG is to reduce the cost of raising money for the most ethical companies by inflating their share prices then, by definition, as an ESG investor aren't you buying overpriced stocks? Or, to put it another way, if I'm after pure investment returns and don’t care about the broader impact of my investing choices then shouldn’t I shun these highly rated ESG stocks and instead go for the kind of unloved companies that might score really badly? Isn't there a tension here?
Jess: With ESG investing it’s about identifying the companies that are sustainable in the broadest sense. So, yes, their products are having a positive impact on the environment or society – but also they are generating strong revenue growth, they are generating strong cash flow. So they need to be good investments that are going to generate a positive financial return, as well as meeting ESG and sustainability criteria. So when we look at the whole spectrum of sustainable investing funds, the ones that are going to be successful over time are going to be the ones that generate positive investment returns. Now, there's a debate to be had about what is the right valuation for any company, not just those that are being bought by ESG funds, but certainly there's a real focus in sustainable investing on generating attractive financial returns. There's no desire to accept a lower return just because it's an ESG fund. And I just go back to the point I made earlier as well, that the analysis that's being done on ESG is trying to identify some of those externalities that are not yet being priced in. So a company where they will benefit from having low carbon emissions over time versus one that actually could end up having a high cost base. The ones that are investing in their workforce, so they'll have lower employee turnover and higher productivity – which, again, should result in superior financial performance and therefore better valuation as well. So there's a real close link between the financials and the ESG.
I think we're at an exciting point in this whole growth in sustainable investing because there are now so many possible ways to invest your money along sustainable lines. And so whatever your own personal preferences, whether you want it to be sort of a light-touch ESG or whether you have very strong values that you want to be aligning with, there were products out there which offer a way to invest from a sustainability perspective whilst also having it tailored to your own personal approaches. And I think we've definitely seen over the last couple of years a real surge in interest that's just continuing across all regions. And so I think this is also really then creating more and more interesting opportunities as well.
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