Over the summer, we’ve seen the beginnings of an ‘ESG backlash’. Former BlackRock Sustainable Investing CIO, Tariq Fancy, published an essay calling ESG a ‘dangerous distraction’ from reality, and the SEC are investigating DWS’s sustainability claims after greenwashing concerns. WHEB will publish a white paper on impact investing in listed equities detailing our approach later in the year, but in the meantime, Head of Research, Seb Beloe, considers ‘Is ESG investing a waste of time?’ in this month’s commentary.

The IPCC’s ‘Code Red’ report published last month is sobering reading. The main takeaway is the now-irrefutable link between human activity, global warming and extreme climate events. We all have a role in solving the problem, and that includes investors. Associate Fund Manager, Victoria MacLean, explores what WHEB is doing to engage with portfolio companies over net zero targets and accountability, assesses carbon prices and explains why efficiency is still important.

WHEB has appointed a new member of our independent Investment Advisory Committee. We are delighted to announce that Alice Chapple, Director of Impact Value and authority on sustainable investment, has joined the committee.

Ty Lee, Associate Fund Manager, spoke to The Big Exchange about WHEB’s approach to impact investing and highlights stock examples which are enabling a sustainable recovery from the pandemic.

In case you missed it, here are the video highlights of Ted Franks’ interview with ESG Clarity magazine in their impact edition.

Top Holdings (alphabetically)

Agilent Technologies

United States

Health Care

CSL

Australia

Health Care

Daifuku

Japan

Industrials

Danaher

United States

Health Care

Ecolab

United States

Materials

Icon

United States

Health Care

Keyence

Japan

Information Technology

MSA Safety

United States

Industrials

TE Connectivity

United States

Information Technology

Thermo Fisher Scientific

United States

Health Care

Global markets continued to rise in August, underpinned by central bank support, strong corporate earnings, and fiscal spending plans. Whilst the spread of the COVID-19 Delta variant, forthcoming Fed tapering, inflationary pressures and China’s regulatory crackdown continue to be risks lurking in the background, the MSCI World Index recorded its seventh straight monthly gain.

The Fund outperformed this benchmark in August, having returned 3.80% versus 3.08%. Outperformance mainly came from our Health and Wellbeing themes. On the other hand, the Education and Water Management themes were relatively weak.

The Health theme made the biggest positive contribution to performance in August, led by Agilent and Danaher. Agilent is a specialist in the development and manufacture of bio-analytics for the life sciences and chemical analysis industries. Recent results showed robust growth, propelled by Agilent’s strong market position in the life sciences, diagnostic and analytical divisions. Danaher is a leading provider of measurement equipment that goes into clinical and medical laboratories, as well as environmental applications. The share price has shown continued momentum from good results reported in July.

Our Wellbeing theme also performed well this month, driven by outperformance from HelloFresh. It is a leading supplier of meal kits to consumers around the world. The meal kits use fresh ingredients in pre-measured quantities allowing for calorie control with the intention of supporting healthy eating. The company continues to see a very strong demand and has also successfully entered new markets, which should lay the foundations for future growth.

The weakest performance this month was the Education theme. We have just two holdings in the theme: Grand Canyon Education and Strategic Education. Grand Canyon Education provides education services to universities and colleges including Grand Canyon University and Orbis. Orbis manages nursing and healthcare programmes, which help address the shortage of healthcare professionals in the US. The share price was weak because of slower recent enrolment growth resulting from COVID-related disruption. Strategic Education offers graduate and postgraduate degree courses for adults, primarily targeting underprivileged demographic groups. The company has also been struggling with enrolment trends, given this customer group has been hit particularly hard during the pandemic.  We continue to monitor these businesses and their market very closely but remain optimistic about their prospects.

Our Water Management theme also performed poorly in August. This was mainly due to Advanced Drainage Systems, the leading provider of stormwater management systems. It provides a comprehensive suite of water management products and drainage solutions for use in underground construction and infrastructure. Recent results were a negative surprise to the market, as rising labour and logistics costs put pressure on near-term margins. We believe the company has the pricing power to be able navigate through this inflationary environment over the long term.

We have now largely concluded the earnings season. Common themes from recent results included rising input costs and COVID-related supply chain disruption. While the stock market continues to show strong momentum, underlying economies are not yet out of the woods of the pandemic. We remain cognisant of these economic uncertainties and high valuations in some pockets of the market.

Is sustainable investing a waste of time?

Like many others, the COVID-19 lock-downs were an opportunity to develop new hobbies. One of my new hobbies was to join a film club. A few months ago, we watched ‘The Graduate’ starring a young Dustin Hoffman as the eponymous graduate ‘Benjamin’. A key moment in the film involves a friend of Benjamin’s parents advising him to get into plastics because “there’s going to be a great future in plastics.”

And of course, in the 1960s, when the film was set, getting into plastics would have been great advice. The success of that industry has brought plenty of benefits, but too much plastic has also of course created lots of problems that we are living with now.

If you are talking to a graduate today, I think the advice might be to get into sustainability or even into ‘ESG’. Certainly, that seems to be the ambition of a lot of young analysts today. But might we be storing up future trouble by embracing ESG too unquestioningly?

Like selling wheatgrass to a cancer patient

Tariq Fancy certainly thinks so. Mr Fancy is the ex-Chief Sustainable Investment Officer at BlackRock. He doesn’t just think that ESG is ineffective as other critiques have asserted. In a 40-page essay he claims that ESG is actively dangerous. After leaving BlackRock in 2019, he concluded that ‘our work in sustainable investing was like selling wheatgrass to a cancer patient’. Not only ineffective, but actively damaging because it delays the patient from receiving effective therapies.

Juxtaposed with this view is the argument set out in Sir Ronald Cohen’s book ‘Impact – Reshaping capitalism to drive real change’. This sets out a manifesto for a new way of thinking about finance, putting positive impact at its heart. The book argues that finance can have an enormously positive impact in addressing the critical challenges facing the world today. So who is right?

ESG focuses on reducing investment risk

The first thing to say of course is that ESG and impact investing are not the same.  Fancy characterises ESG as being like ‘good sportsmanship’. For Blackrock perhaps ESG is about trying to get companies to be better corporate citizens. But for most of the market, ESG investing is mainly about managing risk. Recognising that the world is changing, investors analyse exposure to material ESG issues, and assess how well-equipped companies are to mitigate these risks.

ESG investing processes may indeed help to avoid risk (we think they can) but this is not the same as reducing impact in the real world. Divesting a portfolio of carbon stocks is a good way to decarbonise a portfolio, but this divestment does little to decarbonise the economy. (We argue that divestment can have important socio-political ramifications but recognise that divestment itself will have little immediate effect on carbon emissions.)  Fancy is wrong to characterise ESG investing as nothing more than making ‘vague promises to be responsible’. But he is right to call out asset managers who claim ESG investing alone can save the world.

Impact investing focuses on creating positive impact

Impact investing in contrast is explicitly about creating positive impact in the real world. It puts impact at the heart of the investment case and seeks to measure the positive impact in the real world.  ESG is concerned about real world impacts on companies. Impact investing is focused on a company’s impact on the real world.

Is there a business case for ESG?

Fancy also takes issue with claims that there is a financial case for addressing ESG issues (what he calls ‘the overlap between purpose and profit’). Improvements in ‘operational’ ESG – reducing energy use, hazardous waste generation, health and safety incidents – can deliver improvements in financial performance. However, we’d agree that it is an altogether greater challenge to claim a business case when the core product is under-attack. We have seen oil and gas companies improve their health and safety track record over recent decades. It has been much more difficult to get them to give up on their core product.

Impact investors, in contrast, invest in companies that sell products and services that help to reduce carbon emissions and create positive impacts. These are businesses that are enabling a transition to a zero carbon and more sustainable economy. And by enabling this transition, they also benefit from it because they sell more of their products and services. In these cases, revenue growth goes hand-in-hand with more positive impact.

How exactly companies and their investors create positive impact is beyond the scope of this article but is something that we will be addressing in greater depth in a forthcoming white paper.

Regulatory change

Like anyone confronted with the reality of climate change, Fancy believes that society needs to respond systemically and change the entire economy’s relationship with carbon. We wholeheartedly agree. In fact, 456 investors representing $41 trillion in assets also agree. This group, which included WHEB, signed a ‘Global Investor Statement to Governments on the Climate Crisis’ calling for urgent regulatory action to tackle climate change.

For these investors, ESG is not intended to delay regulatory change. Far from it. They are advocating for regulatory change and believe it necessary and urgent. This advocacy isn’t an alternative to ESG investing, but a complement to it.

BlackRock was not a signatory to this letter. In fact, Larry Fink asserted earlier this year that climate change should be addressed through self-regulation alone.  Some investors may be using ESG as a smokescreen aimed at delaying regulation. Tariq Fancy’s critique should be aimed directly at them.