Article by Ben Rundle, Portfolio Manager NAOS Asset Management
The Environmental, Social and Governance (ESG) movement is now more significant than ever. In today’s current climate investors choose companies based on these principles – and for good reason. A responsible approach to ESG factors makes good business sense and can enhance value for investors over time.
We believe that long-term financial stability can only be achieved by a company who follows the core ESG principles. Aside from the principles that concern protecting our environment and reducing gas emissions, there are governance principles that include board quality, board diversity, codes of conduct and shareholder voting rights just to name a few. These principles, in our view, should be at the core of any successful and profitable company.
Investing in quality and highly profitable companies does not come at the expense of sacrificing one’s ESG principles. In fact, the outperformance of companies adhering to ESG principles was recently highlighted during the COVID sell off in March.
Looking at the ASX 200 index versus the ASX 200 ESG index from the February peak to the March low, the ESG index outperformed by over 1.5% as can be seen in the chart below.
Source: Bloomberg
Interestingly however, this performance wasn’t restricted to just the Australian market and in fact was more pronounced in some locations, particularly in the UK as can be seen below.
Given the data set, it is not surprising that BlackRock recently reported that its sustainable funds achieved better risk-adjusted returns during the first quarter of FY21, while 24 of 26 ESG-tilted index funds tracked by Morningstar also outperformed their “closest conventional” counterparts over the same time period.
When digging deeper into this phenomenon, I questioned whether this period was statistically significant given that we also witnessed a large fall in the price of oil. Not surprisingly, companies operating in the oil and gas sector fared particularly badly during the period as the price of crude oil fell from a peak of $65 in January, to a period where oil price futures turned negative in April for the first time in history. ESG indices are typically lacking in representation from oil and gas companies which could maybe explain their outperformance.
Looking back at a longer time period however, this does not appear to be the case. The below chart shows that over the past 5 years, the ASX200 ESG index has outperformed the ASX200 index by around 3.5% per annum.
Source: Bloomberg
Hamburg University and Deutsche Asset Management have performed a comprehensive review[i] on ethical investing, concluding that the business case for ESG investing is empirically well founded with 90% of ESG studies showing a positive, or at worst neutral, relationship between ESG investing and financial performance across regions and asset classes. A separate analysis by Oxford University and Arabesque Partners[ii] found that 88% of studies indicate that solid ESG practices result in better operational performance, and 80% show that the stock price performance of companies is positively influenced by good sustainability practices.
Going forward we believe that demonstrating leadership in ESG is ultimately a differentiating factor that benefits all parties. At NAOS we strive to create a positive impact on social, environmental and governance issues. We choose our investments based on a long list of criteria which include their ability to grow their revenue base, their pricing power, scalability, as well as their capability to internally fund their expansion.
Along with these criteria we make a conscious decision to exclude any company that doesn’t align with our responsible investment goals. This includes tobacco, gambling, nuclear & uranium, controversial weapons, coal mining operations, oil & gas production and animal cruelty.
NAOS is a signatory to the United Nations-supported Principles for Responsible Investment (PRI) and is guided by these principles in incorporating ESG into our investment practices.
[i] https://www.tandfonline.com/doi/full/10.1080/20430795.2015.1118917
[ii] https://arabesque.com/research/From_the_stockholder_to_the_stakeholder_web.pdf
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