The brave new world of sustainability

For investors who wanted strong performance matched with feeling good about the way their money was used, the ‘ethical’ or ‘green’ funds introduced in recent years satisfied a growing demand.

Fund managers are quick to recognise an opportunity when they see it, and new investment opportunities grew rapidly, even if it meant simply hiring a couple of mainstream fund managers to become ethical specialists.

Funds managers that are venturing into the ethical, green or socially responsible space for the first time now face some thorny issues that were often brushed aside when the market was in its infancy.

First, everyone’s ethics are different. Where one investor may feel nuclear power is the answer to greenhouse gases, another may be worried by the increase in nuclear material around the world at a time when terrorism in one of society’s biggest threats.

Second, many so-called ethical portfolios were remarkably similar to the non-ethical funds offered by the same manager, minus a few stocks.

Furthermore, a methodology that imposes a negative screen on a portfolio, excluding industries such as gambling, tobacco, forestry or mining, may not maximise investment performance.

And green portfolios that use positive screens seem to confine their investment horizon to limited opportunities.

A fund that considers various aspects of sustainability addresses the limitations that ethical or green options are saddled with.

Generation Investment Management, whose Global Sustainability Fund is now available on Colonial First State’s FirstChoice platform, considers the following factors when choosing where to invest:

n climate change — the effect of global warming and associated regulation;

n pandemics and health — how pandemics such as HIV, diabetes and obesity will affect a company’s bottom line;

n human resources — staff acquisition, retention strategies and corporate culture;

n corporate governance — a company’s ability to manage checks and balances and the relationship between shareholders and management;

n stakeholder management — how well a company engages its relationship with suppliers, clients and the community; and

n future licence to operate — ability to respond to future regulation changes.

Importantly, sustainability investing emphasises the goal of maximising investment returns.

It’s not just a feel good exercise, but a process.

A sustainability fund manager recognises that economic, health, environmental, social and governance factors affect the strategy and performance of companies.

Companies that are attractive to sustainability fund managers are those that understand and respond to these factors and have the potential to profit the most from changes over the medium to long term.

For example, increasing wealth in India and China is leading to a rise in health issues relating to western ailments, such as obesity and diabetes.

Climate change creates opportunities for companies specialising in energy-efficient resource usage, or carbon exchanges.

The rise in corporate governance requirements increases the appeal of companies with strong governance controls.

Essentially sustainability investing integrates sustainability research with fundamental equity analysis to produce a new way to take advantage of the way the world is changing.

It is becoming increasingly apparent that sustainability is already affecting the value of companies. Broker reports include an analysis of the carbon effect of a company’s operations, with favourable reports, for example, where an energy company was switching to renewables.

No company could construct a major office building without making it energy efficient, as all major tenants have developed greenhouse-friendly requirements. And, in the future, any company that ignores the way the world is changing will find suppliers, clients, staff and the community will begin to turn away.

Leading companies are incorporating environmental, social and governance (ESG) issues into their operations. ESG issues are becoming more significant as factors that may place business value at risk, and therefore affect the company’s bottom line.

For funds managers, the United Nations Principles for Responsible Investment (PRI) provides a formal framework for incorporating ‘sustainability’ into the funds for which it is investment manager.

The world is changing and there are opportunities for investors who would like to direct money to companies that position themselves to take advantage of long term global changes, and become part of the solution to the planet’s need for sustainability.

Graham Hand is the general manager of alliances at Colonial FirstState .