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Shareholders & Stakeholders

Date: 06.02.2019
5 Minute Read
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Once a niche trend, responsible investing has now entered the mainstream. That shift reflects both changing societal expectations and growing evidence that good companies perform better.

Responsible investing has a long history, dating back to at least the 18th century, when English Quakers refused to invest in slave-trading companies. Far more recently, in 2006, the United Nations and a small group of institutional investors launched the Principles for Responsible Investment (PRI), accelerating a movement that currently includes over 2,000 global signatories. Collectively, those investors and asset owners represent more than $82 trillion in assets owned or under management.

The PRI is not prescriptive – you do not have to exclude specific companies or investments, for example  – which is part of the reason it has gained such a wide following. Indeed, the PRI recognises that “responsible investment” means different things to different people. Such strategies also come under different names: responsible, sustainable, socially responsible, impact investing and so on.

A broadly accepted distinction is often made between an investment strategy that’s strongly driven by specific values – such as the exclusion of tobacco, alcohol or weapons – and one that takes fewer, if any, absolute positions but still seeks to take into account relevant environmental, social and governance (ESG) factors.

Consider the pacifist Quakers, who refused to invest in slavery three centuries ago. Today, they do not invest in companies that manufacture weapons. Such a strategy – where values play an absolute role in investment decisions – is typically called “sustainable” or “socially responsible,” while the broader incorporation of ESG factors is known as “responsible.”

But, you may ask, will a responsible strategy limit my investment universe and lead to lower returns? That’s a legitimate concern, but we believe the simple answer is no.

The rise of responsible investment
PRI assets under management (USD TRN) & signatories

Source: Principles for Responsible Investment

Industry research shows that the top 20% of ESG companies have consistently outperformed the market. Indeed, investors are constantly seeking to limit their investment universe by excluding poorly run or excessively risky companies. Considering ESG issues – the key element of responsible investing – is an attempt to evaluate and avoid risk from factors not always associated with investment decisions in the past.

These risk factors are increasingly recognised as being important to successful long-term investing, and to all stakeholders.

While day-trading remains popular with some and trading desks at market-makers and commodities firms are continually buying and selling in response to price movements, the consensus is that long-term investing produces better returns for most investors. But what does that mean? In the middle of the 20th century, the average holding period for US equities was 7-8 years. That has since declined to 7-8 months.

Over the same period, US life expectancy has risen from about 65 years to almost 80 years, so the investment horizon of insurers and pension funds has lengthened accordingly. A 20-year-old lucky enough to join a pension fund today creates a 60-70-year obligation.

However, from a certain perspective – that of all our stakeholders – even 60-70 years still looks short term.

The idea of a “stakeholder” is an extension of the idea of a “shareholder,” who is part owner of a company. Far more people than shareholders are impacted by what a company does. Customers, employees, suppliers, society and even future generations can all be considered stakeholders.

It has often been argued, especially in the United States, that only shareholder value is relevant when making business decisions. In Europe, by comparison, it has long been accepted, and even legally required, to consider more than just shareholder value. A sole focus on shareholders is too narrow, and often leads to short-term gains at the cost of long-term returns.

Responsible investing seeks to take into account all relevant stakeholders because this is seen as consistent with better management of business risk, leading to better long-term returns. And so when we talk about “long term” in this perspective, we have to explicitly consider future generations.

This is a fairly recent development, as awareness has increased that the resources of the earth are not inexhaustible, that the ability of the earth to absorb our waste is not limitless and that technology may not save us from ourselves.

Millennials look with increasing concern at the world they are inheriting, and it should not be surprising that they are putting their money into responsible investments at a rate that is twice as high as the average investor. There is not enough room to go into the entire climate change debate here, but two points of view should be enough to reframe the discussion: fire insurance and our children.

You don’t have to accept the overwhelming scientific evidence that humankind is changing the global environment for the worse to agree that it makes sense to take action.

Think of your own home. The odds that it will be consumed in a fire are quite small. Yet almost all of us consider it prudent to purchase fire insurance because the cost of a fire is so high.

The analogy with climate change is not perfect. The cost of such “insurance” – that is, taking action to prevent global climate change – will be much higher for each of us than typical homeowner’s insurance, while the potential cost of predicted climate change is almost incomprehensibly high.

We can all picture what it would mean if our home were laid waste by fire, but it’s very hard to imagine what it would mean if sea levels were to rise by 10 meters. We humans are notoriously bad at accurate risk assessment, and remote risks are difficult to weigh against immediate costs. So the tendency to defer and disregard is understandable – even though future generations may pay the price.

“Future generations” is another abstract and remote concept, easy to ignore when making investment or other decisions. But if we make it concrete and talk about our children, grandchildren or their children, it suddenly becomes far more real.

If we leave our grandchildren a fortune in a world that is uninhabitable, will they still thank us? Probably not. That’s one reason (but certainly not the only one) why millennials are embracing responsible investing, and why they espouse a different set of priorities when responding to surveys about wealth and their future.

Millennials are very much stakeholders in the businesses of today, and we should take them into account as part of our investment decisions.

Does that mean we should all embrace a buy-and-hold strategy for the next 100 years? Certainly not.

General Electric, the last remaining original member of the Dow Jones Industrial Average, was the most valuable public company in the United States as recently as 2005. Today, it is a shadow of its former self and was removed from the index in 2018.

Judging the fair price of a share, given its potential return, continues to be as difficult as ever. But responsible investing adds fresh perspective to that assessment, adding ESG risks into the mix.

A company with significant holdings in coal, or a coal-fired energy producer, runs a high risk if a carbon tax is introduced. And a company that ignores questions about child slave labour in cacao production runs an equally clear reputational risk.

These factors are increasingly important in investment decision-making as more and more investors adhere to the Principles for Responsible Investment. Companies like Microsoft and Royal Ahold Delhaize – both of which boast low ESG risks – become relatively more attractive by this standard, although low ESG risks alone do not guarantee a sound investment.

The world is changing ever more rapidly, and investors have to take newly recognised risks and different time horizons into account. Not doing so would be irresponsible.

Responsibility pays
Performance of Sustainable Europe Index Fund  & MSCI Europe (rebased to 100)

Source: FactSet

Brown Shipley Investment Office

This article appears in our Global Investment Outlook 2019. An indepth look at the key trends and big ideas that will shape the global investment outlook over the next 12 months. Download a copy of this document here.

This article is for information purposes only. It does not constitute investment advice and is not a recommendation for investment. The value of investments and any income from them may fluctuate and are not guaranteed. Investors may not get back the amount originally invested. Past performance is not a reliable indicator of future results. Currency fluctuations may cause the value of underlying investments to go up or down.

 

Except insofar as liability under any statute cannot be excluded, neither Brown Shipley nor any employee or associate of them accepts any liability (whether arising in contract, tort, negligence or otherwise) for any error or omission in this document or for any resulting loss or damage whether direct, indirect, consequential or otherwise suffered by the recipient of this document. © Brown Shipley 2019 reproduction strictly prohibited.

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