Readers of a certain age will probably recognise the title as a play on the chorus of Crosby, Stills & Nash’s 1969 hippy anthem, ‘Marrakesh Express’. ESG, on the other hand, is a little less long in the tooth. It stands for Environmental, Social and Governance and is an investment trend fast approaching the mainstream. I deliberately used the railway metaphor because to my eyes, not only is this a train that’s picking up speed but I have a feeling many will end up with a ticket, whether they wanted one or not.
For long enough, investors have omitted certain sectors or companies from portfolios. Tobacco was the obvious bête noire but oil and gas appear to be going the same way. Removing what you don’t like is an example of negative screening. Conversely, positive screening includes businesses perceived to confer a degree of social ‘good’. It is the latter that sits at the heart of ESG.
Now, at this juncture, I should make it clear I agree with 18th century essayist, Samuel Johnson’s aphorism, (though, on second thoughts, it might have been Chris Rea’s) that “the road to hell is paved with good intentions”. There is also much to commend author, Vikram Seth’s 21st century update; “God save us from people who mean well”. It’s not that I am against good deeds but I conclude a preaching orthodoxy has taken root, here. Increasingly, we are being told which sectors/companies are ‘good’ or ‘bad’, when filtered through a variety of metrics. I’ve seen far more criticism of tobacco products than I have of cannabinoids. Is this sensible? You may feel warm and fuzzy owning shares in Tesla or even owning a Model S but how much plastic does it contain? An acquaintance of mine recently mentioned they were trying to lower their carbon footprint but sheepishly answered ‘no’ when I enquired if they had sold their foreign holiday property. As you can probably tell, while I’m certainly playing Devil’s Advocate, I also believe a little too much of this is cloaked in hypocrisy ………… there, I’ve said it.
However, my main concern surrounding ESG is not the holier than thou message that accompanies some, though not all of it. It’s the potential confusion arising from where the investing stops and the altruism starts. There isn’t a set definition of what ESG investing should encompass but I suspect Legal & General’s is not untypical. ‘All forms of responsible investment have ESG at their core. Environmental issues are those relating to our planet such as climate change, population growth and deforestation. Social issues centre on factors such as wealth inequality, gender discrimination and homelessness while governance involves balancing the interests of company management with those of their employees and suppliers.’ To be blunt, I struggle to see how some of this could be categorised as investment at all.
But wait, there’s more. Within the ESG category sits Impact Investing. Again, a plethora of definitions abound but according to the Global Impact Investing Network, ‘impact investments are made with the intention to generate positive, measurable social and environmental impact alongside a financial return’ or, as I prefer to describe it, ‘……. alongside a financial return that may be well shy of a market rate.’ The Impact Investing Institute is a UK based non profit organisation that wants to ‘mobilise large pools of capital, such as defined contribution pension funds to make impact capital more accountable and empower people to save and invest in line with their values’. Its CEO (Chief Executive Officer), Sarah Gordon, wants “financial advisers to be thinking not just about ESG but about positive impact”. As Mandy Rice Davies didn’t say but I will “well she would say that, wouldn’t she?” And, let’s not forget, it’s the adviser’s job to reflect the client’s wishes, not the other way round.
Which brings me to the crux of my argument. Unless ESG/Impact Investing is described fairly and accurately, some investors may be offered it and conclude its implementation carries no extra risk. Who doesn’t want to ‘do good’? But what if these investments don’t deliver the same level of return? We know from the off that some never expect to and if that is so, investors need to be fully aware ex ante.
The mathematics of compounding means small annual variances become substantial over significant periods of time. As a very rough rule of thumb, an expected average return from equities might be in the region of 8% p.a. over the long haul (whether it is delivered is another matter entirely). But, just for the sake of illustration, let’s look at simple examples. If £100,000 compounded at 8% p.a. over 25 years and 40 years respectively, the resulting capital sums amount to £685,000 and £2,172,000. If the annual compound return fell to 6%, however, the sums become £429,000 and £1,029,000. If your future standard of living depended upon hitting 8% rather than 6%, you’ve got a problem.
In my view, no investment should be undertaken without a sensible (and I mean sensible as in realistic, not woolly, box ticking conjecture) estimate of what the likely risk and return might be. You may suspect that I’m anti ESG but that’s not so. The companies we buy tend to be long established successful enterprises that have proven their ‘sustainability’ or else they wouldn’t be around. Many also have a visible track record of looking after their workforces. However, I foresee situations arising where the ambiguity of the initial premise fatally compromises the investment case. And if, from a financial perspective, performance is poor, it offers a Get Out of Jail Free card to the adviser/fund manager who can always commandeer the excuse that some of the ‘return’ was always expected to be non-financial. Try spending that once you’ve retired.
The value of investments and any income from them can go down as well as up and you may not get back the amount originally invested.
This material should not be considered as advice or an investment recommendation. Investors should seek advice from an authorised financial adviser prior to making investment decisions.