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Foster Denovo|News & opinion|News|Market Briefing – 10th September

Market Briefing – 10th September

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 brought this desire into sharper focus. The long-held assumption was that ethical or green investing – as ESG was and is still often referred to – implied lower returns. 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, 2020 has suggested 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.

 “Never let the truth get in the way of a good story.” Mark Twain

The growth in the FANMAG (1) stocks in 2020 has been well documented in the performance of the S&P 500 in £ terms (2), as shown below when compared with the UK’s FTSE 100 (3).

Source: Financial Express (4)

It also shows the ability of the S&P 500 index to have recovered from the market impact of the pandemic, something the FTSE 100 is still to deal with. However, when viewed through the ESG lens, things take on a different – and to some, a surprising – turn of events. But more of that later…

So 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 aims comes an essential investment criterion; that of the aforementioned 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 during the pandemic period? As the graph below shows …

Source: Financial Express (4)

… during 2020 the ‘mainstream’ S&P 500 ETF, in £ sterling (5) (a passive fund that tracks the US S&P 500 index), has underperformed its S&P 500 ESG Screened ETF cousin, in £ sterling (6) (a passive fund which tracks big US companies with high ESG ratings), by just under 15.5% (6.33% versus 7.31%). So rather than paying through underperformance for using ESG focused investments, the opposite appears to be true.

What about the UK?
As mentioned earlier in terms of the FTSE 100, UK markets have not reacted in any way similar to their US counterparts; in the main due to the FANMAG stocks cited above. So rather than showing a positive return, UK markets in general are still below their late February, pre pandemic, peaks. That said, although comparing a fund with its fees against an index, the graph below clearly shows the difference ESG focused investing has had in 2020.

Source: Financial Express (4)

When compared with the non ESG focused MSCI United Kingdom (UK) index (7), the MSCI UK SRI (socially responsible investing) index, an ESG focused passive index (8) (which is a subset of the main MSCI UK index, filtering the top 25% of companies based on their ESG scores), shows ESG investments holding up well. Although loss at any time is not comfortable, this clearly shows that ESG focused investments have performed better – in this case by over 50% – when compared with non ESG counterparts.

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, ESG investments have lower exposure to fossil fuel assets. This has protected ESG investments when oil prices collapsed this year. In addition, pharmaceuticals have been boosted due to medical supply requirements in the treatment of the pandemic; for example, an increase in oxygen usage.

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.

Former US Vice President, Al Gore

So 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 this 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.” (9)

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.

Although it does not guarantee against loss, smart diversification is the most important component of reaching long-range financial goals while minimising risk.

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 very often have a long-term investment time horizon.

As we have said before, we will continue to monitor the current financial situation and keep you notified of any changes that are made. Please seek professional financial advice if you wish to discuss your financial situation further.

The next market briefing will be published on 23rd September 2020.

Sources and references
1) Facebook, Apple, Netflix, Microsoft, Amazon, Google (owned by Alphabet Inc.)
2) The S&P 500 or Standard & Poor’s 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The index is widely regarded as the best gauge of large-cap
U.S. equities. Other common U.S. stock market benchmarks include the Dow Jones Industrial Average or Dow 30 and the Russell 2000 Index, which represents the small-cap index – https://www.investopedia.com/terms/s/sp500.asp
3) The Footsie is an index that tracks the 100 largest public companies by market capitalization that trade on the London Stock Exchange (LSE). The FTSE 100 represents roughly 80 percent of the LSE’s market capitalization. FTSE is an acronym for the Financial Times and the LSE, its original parent companies. The FTSE is now owned and maintained by the LSE. It has similar importance in London to the U.S. Dow Jones Industrial Average and S&P 500 and is a major indicator of the performance of the broader market – https://www.investopedia.com/terms/f/footsie.asp
4) Financial Express FE Analytics
5) The S&P 500 Index is a float-adjusted, capitalisation weighted index of the top 500 companies in the US market. The Index is designed to provide exposure to the large cap segment of the U.S equities market and spans over 24 separate industry groups. It captures approximately 75% of the market capitalisation of US equities – https://www.ssga.com/doc/factsheets/FS1504_English.pdf 6) The objective of the Fund is to track the U.S. equity market performance of large cap equity securities. The investment policy of the Fund is to track the performance of the Index (or any other index determined by the Directors from time to time to track substantially the same market as the Index) as closely as possible, while seeking to minimise as far as possible the tracking difference between the Fund’s performance and that of the Index. 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. Index constituents may on occasion be rebalanced more often than the Index Rebalance Frequency, if required by the Index methodology, including for example where corporate actions such as mergers or acquisitions affect components of the Index –
https://www.ssga.com/library-content/products/fund-docs/etfs/emea/supplements/en-supplement-57spdr-sp-500-esg-screened-ucits-etf.pdf
7) The MSCI United Kingdom SRI Index includes large and mid cap stocks of the UK market. The index is a capitalization weighted index that provides exposure to companies with outstanding Environmental, Social and Governance (ESG) ratings and excludes companies whose products have negative social or environmental impacts. The Index is designed for investors seeking a diversified Socially Responsible Investment (SRI) benchmark comprised of companies with strong sustainability profiles while avoiding companies incompatible with values screens. Constituent selection is based on research provided by MSCI ESG Research – https://www.msci.com/documents/10199/228306e4f2b7-4cfb-8219-dd9eba31f067
8) The MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. With 87 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the UK – https://www.msci.com/documents/10199/587e9bae0a65-49e8-b1c6-bb84cf061441
9) https://considerategroup.com/summer-news-bulletin-2020/

This publication is marketing material. It is for information purposes only. This statement is for the sole use of the recipient to whom it has been directly delivered by their Foster Denovo Partner and should not be reproduced, copied or made available to others. The information presented herein is for illustrative purposes only and does not provide sufficient information on which to make an informed investment decision. This document is not intended and should not be construed as an offer, solicitation or recommendation to buy or sell any specific investments or participate in any investment (or other) strategy. Potential investors will have sought advice concerning the suitability of any investment from their Foster Denovo Partner. Potential investors should be aware that past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and they may not receive back the amount they originally invested. The tax treatment of investments depends on each investor’s individual circumstances and is subject to changes in tax legislation.

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