John Berry: ESG investors simply back better businesses

ESG investing can and does generate good outcomes for investors and the planet. Photo / File

COMMENT:

Environmental, social and governance (ESG) investing is ascendant, making good sense for investors and good sense for our planet.

This view stands in direct contrast to Financial Times columnist Robert Armstrong's opinion published in the New Zealand Herald last week: 'The dubious appeal of ESG investing is for dupes only'.

Armstrong said ESG investing is "not cause for celebration". It has "weak conceptual foundations" and it "should be viewed suspiciously by investors who seek adequate returns."

So, it is virtue signalling with poor returns.

But he is wrong. ESG is underpinned by two quite distinct drivers - 'value' (risk/return) and 'values' (ethics).

Let's deal with the 'value' question first. People invest in KiwiSaver to maximise returns and provide for their golden years. Investing ethically shouldn't hinder that, and it doesn't.

Armstrong rightly argues the cash tsunami funnelled into ESG funds should increase the cost of capital for fossil fuel, tobacco, and gambling companies. It should result in weaker demand for their shares and bonds, making it more expensive for them to raise new capital.

For the same reason companies that take ESG matters seriously should enjoy stronger demand for their shares and bonds and therefore find it easier to finance projects.

But Armstrong runs off the rails suggesting "… all else being equal, that must mean lower returns…" He believes investors who care about ESG factors will do worse than those who don't care.

Armstrong's view relies on the flawed idea that a company can have a rock bottom ESG score and still operate a resilient, strong, and growing business. Of course, there are exceptions, but in my view poor ESG scores are indicative of less resilient businesses. Over the long-term these will deliver, in aggregate, lower returns.

ESG investors believe their approach offers new tools to scrutinise companies in the same way as Benjamin Graham and Warren Buffet pioneered 'value investing' as an investment paradigm.

ESG tells us a lot about potential financial risks.

Consider a company lacking independent directors, hiding related party transactions and rewarding executives solely on short-term goals. Poor governance indicates a company unlikely to realise it's potential. Its bad for shareholders and other stakeholders.

The same is true of a company that places a low priority on environmental protections. Just ask BP which ended up with a US$65 billion ($96b) environmental disaster in the Gulf of Mexico.

Conversely, a company that rewards employees with fair pay, good working conditions and ongoing training can expect higher productivity and lower staff turnover. Such practices can make a business more innovative and profitable. Just ask Salesforce, Microsoft, or a host of tech companies that "get it".

A large plume of smoke rising from BP's Deepwater Horizon offshore oil rig in the Gulf of Mexico in 2010. Photo / AP

This is not wishful thinking. Work by the New Zealand Super Fund, Morningstar and McKinsey demonstrates that when it comes to investing globally, ESG can improve long-term returns and lower risk.

And now let's move to the question of 'values' (ethics).

Armstrong argues it is the role of government and the rule of law to tackle issues like minimum wages and carbon emissions. Apparently, we don't want companies having more "power and responsibility for solving our most pressing problems, from inequality to climate change".

On this I fundamentally disagree. We do want companies to have those responsibilities – using their resources and smarts to find solutions. Governments can't legislate for innovation, for new technologies or for passion to solve challenges. Companies can create the environment where those things happen. And people increasingly expect them to.

Many want to spend their money or invest their savings to positively impact the world. If someone doesn't want to buy goods made with child labour, that's their choice. If investing in the company using child labour feels like enabling unethical behaviour, that's their call.

Whether it's gambling, animal testing, tobacco manufacture or power stations burning coal, everyone has different views. This "values" part of ESG investing is personal.

That's why it's a good thing there are around 30 KiwiSaver providers who invest with different value sets. You can have tobacco, weapons and fracking in your KiwiSaver if you want it. The responsibility of KiwiSaver providers is to be fully transparent and make it clear what value set, if any, they embed in their investing. To be fair, some managers do a good job around transparency, others not so good.

Armstrong suggests ESG supporters believe in a perfect world where "shareholder returns and the social good always align." No, this is a far from perfect world. But ESG investing can and does generate good outcomes for investors and the planet. That's why it must be the future.

- John Berry is CEO of Pathfinder Asset Management and the CareSaver KiwiSaver Plan, both of which put ESG matters at the heart of their investment decisions.