Market briefing (no.41)

Market briefing (no.41) – 8th November 2021

COP26, Glasgow 2021

Glasgow is staging the annual UN Climate Change Conference of the Parties (COP) number 26 summit during the first two weeks of this month. COP26 brings international parties together to accelerate action towards the goals of the COP21 Paris Agreement and the UN Framework Convention on Climate Change.

What does COP26 hope to achieve? (1)

Four objectives:
1) Secure global net zero by mid-century and limit global temperature rise to 1.5 degrees of the pre industrial revolution level.
Countries are being asked to come forward with ambitious 2030 emission reduction targets that align with reaching net zero by the middle of the century. To deliver on these stretching targets, countries will need to accelerate the phasing out of fossil fuels, such as coal and oil, encourage investment in renewables, curtail deforestation and speed up the switch to electric vehicles.

2) Adapt to protect communities and natural habitats
The climate is already changing and it will continue to change even as we reduce greenhouse gas (GHG) emissions, with devastating effects. At COP26 attendees will need to work together to enable and encourage countries most affected by climate change to protect and restore ecosystems, build defences, put warning systems in place and make infrastructure and agriculture more resilient to avoid loss of homes, livelihoods and lives.

3) Mobilise finance
To realise the first two goals, developed countries must deliver on their promise to raise at least $100 billion in climate finance per year. International financial institutions must play their part and need to work towards unleashing the trillions in private and public sector finance required to secure global net zero.

4) Work together to deliver
The challenges of climate change can only be overcome by working together. At COP26, the Paris Rulebook (the rules needed to implement the Paris Agreement) must be finalised. And, ambitions must be turned into action by accelerating collaboration between governments, businesses and civil society to deliver on the climate goals faster.

What’s good for investing is good for the planet

The official ‘COP26 Explained’ says when discussing ‘Mobilse Finance’, “To achieve our climate goals, every country, every company, every financial firm, every bank, insurer and investor will need to change.”(1)

Mark Carney – the former Governor of the Bank of England – is now the UN Special Envoy on Climate Action and Finance. Recently interviewed, he was clear about how private finance is becoming greater aligned in achieving net-zero greenhouse gas emissions.

He said, “Private finance is judging which companies are part of the solution, but private finance, too, is increasingly being judged. Banks, pension funds and asset managers have to show where they are in the transition to net zero. And people are voting with their money. That is creating the type of investment that we’re going to need to get to net zero.”(2)

In line with Mark Carney’s comments, a growing number of investors are demanding investment choices that do more than provide them with a rate of return. Whilst seeking options that will help their assets grow, managing the risks to this growth from environmental, social and governance (ESG) factors is becoming more of a priority. As a result, some investors are looking to avoid investing in companies that do harm, and support those that benefit society in some respect.

The pandemic has also brought this desire into sharper focus. The long-held assumption was that ethical or green investing – as ESG was and is still often somewhat erroneously referred to – implied lower returns. The assumption implied there was a cost to be paid for investing in more sustainable companies. Whilst always acknowledging that past performance is never a guide to future returns, the period since the beginning of 2020 – which includes the significant bear market caused by the pandemic in February and March 2020 – suggests the opposite and shows that investing, whether to mitigate ESG risk factors or more progressively to actively encourage sustainable opportunities, does not involve sacrificing returns.

What is ESG investing?

Simply put, ESG investing provides investors with opportunities that avoid investing in companies that do harm, and support those that benefit society in some respect.

The ‘E’ – ‘Environmental’ – takes into consideration the impact companies are having upon the planet today and in the future, such as pollution, waste and emissions; renewable energy and efficiency; and recycling. The ‘S’ – not sustainable, but ‘Social’ – takes into consideration the social impact companies are having upon people in the world, such as human rights; workers’ conditions and rights; and relationships with suppliers and customers. The ‘G’ – ‘Governance’ – takes into consideration the interests of all stakeholders affected by the company’s activities, such as avoidance of bribery and corruption; equality and diversity; health and safety, and compliance with regulations.

In addition to the above, comes an essential investment criterion, that of risk mitigation. Simply put, poor ESG practices may ultimately be harmful to a business. ESG means favouring companies that value long-term business sustainability, not just short-term profitability, and in the long run that should lead to better long-term financial returns for investors.

But does the market show this for the period since the beginning of 2020?

Whilst always remembering that past performance is no guide to future returns, the graph below compares two passive funds that seek to track the performance of the largest companies within the US stock market, namely the S&P 500 index.(4)

The first of these two funds – shown by the dark blue line – is the ‘mainstream’ S&P 500 ETF
(5) which is a passive fund that tracks the US S&P 500 (4) index (with performance shown in £ sterling(6)).

The second fund – shown by the green line – is the S&P 500 ESG Screened ETF (5) which tracks big US companies with high ESG ratings in the S&P 500 (4) (with performance shown in £ sterling(7)).

As the graph below shows, the ‘mainstream’ S&P 500 ETF – the dark blue line – has marginally underperformed its S&P 500 ESG Screened ETF cousin – the green line – by just under 2% (41.08% versus 42.87%).

So rather than suffering underperformance for using ESG focused investments, the opposite appears to be true.

What about the UK?

Similar to the US, the graph below compares two passive funds that track, or follow a broad UK index.

The first of these two funds – shown by the light blue line – is the ‘mainstream’ iShares MSCI UK ETF (5), (with performance shown in £ sterling(8)).

The second fund – shown by the green line – is the UBS MSCI United Kingdom IMI Socially responsible ETF (5) which is an ESG focused passive fund (with performance shown in £ sterling(9)).

As the graph shows, the iShares MSCI UK ETF(5) (8) when compared with the ESG focused UBS MSCI United Kingdom IMI Socially responsible ETF(5) (9)


… shows ESG investments performing well. In fact it has outperformed its non ESG competitor by just over 6.00% (6.37% v 0.30%) since the beginning of 2020. So, as was the case with the US, rather than suffering underperformance for using ESG focused investments, at least over this comparatively short, albeit tumultuous period, the opposite appears to be true in the UK too.

Why is this?

In terms of asset types, answers to this question will include oil for the obvious environmental reasons. Although this does not mean they would not invest in oil companies, particularly those with a commitment to develop new renewable energy offerings and transition away from oil production, ESG investments have lower exposure to fossil fuel assets. This can be a two edged sword when oil prices go up, potentially increasing the share prices of oil companies, but the opposite is true in the sense that ESG investments were protected last year when oil prices collapsed.

Another answer, which is more sustainable in the long term, is when more investors buy ESG assets, prices are supported and likely increase.

ESG factors in themselves are also reasons; for example, improved corporate governance and supply chain management. Companies usually need to better audit their supply chains and internal and external logistics, changing them where necessary, together with improving employee practices, to get higher ESG assessments. Regulation will make sure companies report and audit their ESG risks as a matter of business as usual.

Ultimately the reason for ESG investments potentially holding up better than ‘mainstream’ investments are to do with risk mitigation.

As former US Vice President Al Gore said in July last year, “investors who do not recognise this new reality . . . are in serious danger of violating their fiduciary responsibility to their clients by leaving money on the table, and not taking into account factors that can actually improve performance of companies.”(10)

What should this tell you?

Firms who are more aligned to ESG factors are more likely to remain in business for longer and so continue to make profits, benefitting investors. It should also tell you investors should diversify. While individual stocks and markets will continue to go up and down, smart diversification across assets, geographical jurisdictions, styles and philosophies, whilst factoring in environmental, social and governance criteria, can help investors minimise their risks. However, remember that no matter how diversified a portfolio is risk and reward do typically go hand-in-hand and as such, risk can never be eliminated completely.

It is true the short-term horizons shown in some of the graphs above enhance the uncertainty due to the unpredictability of this current situation. However, it is important to remember that we have a long-term investment time horizon.

As we have said many times before, we will continue to monitor the current financial situation and keep you notified of any significant changes that are made. Please contact your Foster Denovo Partner if you wish to discuss your financial situation further.

At times like these, it is even more important that you are taking advice on your finances by a qualified and experienced financial planner. If you think any of your friends, family or colleagues would benefit from speaking to us, especially in the current situation, then please introduce them to your Foster Denovo Partner who would be happy to help.

This week in history …

8th November 1974: Earl Lucan disappears and is never seen again after his nanny is found murdered in London (11)

9th November 1888: Jack Ripper’s 5th and probably last victim, Mary Jane Kelly, found on her bed (11)

10th November 2001: An agreement is reached at talks in Marrakech, Morocco, on rules for implementation of the Kyoto climate change treaty (11)

11th November 1920: The Cenotaph in Whitehall, designed by Edwin Lutyens, unveiled (11)

12th November 1998: US Vice President Al Gore symbolically signs the Kyoto Protocol. (11)

13th November 2020: British strategist and chief advisor to the PM Dominic Cummings is let go by Boris Johnson (11)

14th November 1972: Dow Jones closes above 1,000 for 1st time (1003.16)(11)

15th November 1947: Don Bradman scores his 100th 100, 172 v India at the Sydney Cricket Ground, Australia (11)

Sources & definitions
1) https://ukcop26.org/wp-content/uploads/2021/07/COP26-Explained.pdf

2) https://www.un.org/en/climatechange/mark-carney-investing-net-zero-climate-solutions-creates-value-and-rewards

3) FE Fundinfo

4) S&P 500 — The S&P 500 Index features 500 leading U.S. publicly traded companies, with primary emphasis on market capitalization. The S&P is a float-weighted index, meaning the market capitalizations of the companies in the index are adjusted by the number of shares available for public trading. Because it is widely considered the best gauge of large- cap U.S. equities, many funds are designed to track the performance of the S&P – https://www.investopedia.com/terms/s/sp500.asp

5) ETF — An exchange traded fund (ETF) is a type of security that tracks an index, sector, commodity, or other asset, but which can be purchased or sold on a stock exchange the same way a regular stock can. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies. A well-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index – https://www.investopedia.com/terms/e/etf.asp

6) SPDR S&P 500 UCITS ETF — The objective of the Fund is to track the U.S. equity market performance of large cap equity securities – https://www.ssga.com/library-content/products/factsheets/etfs/emea/factsheet-emea-en_gb-spy5- gy.pdf

7) SPDR S&P 500 ESG Screened UCITS ETF — The Index measures the performance of the top 500 companies in the
U.S. equity market which are weighted by market capitalisation, while aiming to screen out certain securities based on their exposure to controversial weapons, civilian firearms, tobacco, thermal coal and companies deemed not compliant with United Nations Global Compact principles. The adoption of these screens within the Index correspond to the environmental and social factors which the Fund promotes, as further described in the “ESG Screening” subsection of the “ESG Investing” section of the Prospectus. Companies deemed by the Index provider to be compliant with the United Nations Global Compact are considered to exhibit good governance https://www.ssga.com/library- content/products/fund-docs/etfs/emea/supplements/en-supplement-57-spdr-sp-500-esg-screened-ucits-etf.pdf

8) iShares MSCI UK UCITS ETF — The Share Class is a share class of a Fund which aims to achieve a return on your
investment, through a combination of capital growth and income on the Fund’s assets, which reflects the return of the MSCI UK Index, the Fund’s benchmark index. The Share Class, via the Fund, aims to invest so far as possible and practicable in the equity securities (e.g. shares) that make up the benchmark index. The benchmark index measures the performance of large and mid-market capitalisation companies in the United Kingdom equity market which comply with MSCI’s size, liquidity, and free-float criteria. Companies are included in the benchmark index based on a free float
– adjusted market capitalisation weighted basis. Free float – adjusted market capitalisation is the share price of a company multiplied by the number of shares available to international investors. Securities that are liquid means that they can be easily bought or sold in the market in normal market conditions.(3)

9) UBS (Irl) ETF plc – MSCI United Kingdom IMI Socially responsible UCITS ETF A — The Fund seeks to track performance of the MSCI UK IMI Extended SRI 5% Issuer Capped Index (the “Index”). The Index is designed to measure the performance of United Kingdom companies which are considered to have a positive environmental, social and governance focus. The Fund will seek to hold all of the shares of the Index, in the same proportions as the Index, so that essentially the portfolio of the Fund will be a near mirror image of the Index. The Fund may, for the purpose of reducing risk, reducing costs or generating additional capital or income, use derivative instruments. The use of derivative instruments may multiply the gains or losses made by the Fund on given investment or on its investments generally. Currency hedged share classes may also be available in the Fund. This class distributes its net income in order to maintain the maximum tracking accuracy of the MSCI UK IMI Extended SRI 5% Issuer Capped Index. (3)

10) Summer News Bulletin 2020 – Considerate (considerategroup.com)

11) https://www.onthisday.com