For the greater good

When the financial markets are unsettled, is it still possible to get good returns when investing responsibly? Amanda Young examines the key factors in environmental, social and governance issues that you should consider

A responsible approach is vital for investors who wish to maximise long-term returns in today’s challenging investment environment. Put simply, companies that identify and manage corporate governance and social responsibility issues on a consistent and holistic basis are well placed to meet investors’ long-term financial objectives.

Since 2007, there have been unprecedented changes in the global financial market landscape. From an abundance of credit and cheap money, companies, investors and individuals were thrown into a severely constrained environment in which liquidity sources froze. A dramatic period of deleveraging (debt repayment) began with the credit crisis, and is likely to characterise economic activity in many developed-world economies for some time to come. In this context, challenges are abundant for companies and investors alike.

For the good?
As companies adapt to a less forgiving economic backdrop, decisions made in the spheres of environmental, social and governance (ESG) issues, as well as ethical matters, are likely to have a significant impact on long-term fortunes. Here are some of the factors that are important when looking at companies’ ESG activities:
Climate change: as a key theme for responsible investment, climate change remains a pressing issue for governments around the world. The cost implications for heavy industry in a carbon-constrained world are unlikely to abate, and companies must therefore implement appropriate systems and technology to avoid significant financial costs.

Increased regulation and severe penalties: as social responsibility becomes more prominent, lapses in governance and the occurrence of environmental disasters are leading to record-breaking fines, prosecutions and damages payments, as well as strict regulations to prevent recurrence. The Enron scandal still lingers as a reminder of the dangers of unstable corporate governance. The negative publicity which surrounds corporate wrongdoing is also a significant concern; the events of last summer in the Gulf of Mexico, for example, have left an indelible mark on BP, and the compensation to which the company was exposed and the subsequent restrictions on drilling activity in the area resulted in the loss of billions of dollars in earnings.

Politics of state funding: governments are becoming increasingly sensitive to the political considerations of awarding contracts to particular companies, and providing financial support for industries. Companies that address the wider social and environmental impacts of their operations will be better placed to meet increased government scrutiny and to comply with more stringent regulations, which could offer a competitive advantage.

Cost savings: companies that ensure good management of environmental and social risks are likely to achieve financial benefits through long-term cost reductions, for example through investment in systems to reduce their use of energy, raw materials and water.

Engagement with companies: ESG issues vary widely between countries, sectors and businesses, and a thorough, stock-specific approach is therefore vital. Such engagement may range from gaining an improved understanding of current practices and holding constructive discussions with the company, to voting against a particular resolution or the most severe sanction of selling the relevant holdings, or deciding against investment in the first instance. For investors, it is important to recognise that exercising voting rights is an important element in ensuring the success of this engagement activity.

The challenge for companies is to make appropriate investments that will enable them to thrive in a world in which environmental, social and governance inconsistencies are closely scrutinised. The challenge for investors is to identify companies that are addressing these concerns in a manner which will reinforce foundations on which stable, long-term growth can be built.

Tough times
The financial pressures on independent schools have increased in the past year, amid a new environment of cost-cutting, and significant obligations which must be met by charitable organisations.

Additionally, independent schools are heavily influenced by the financial circumstances of parents, many of whom will have experienced adjustments to their own financial plans and management as a result of the credit crunch. Carefully structured investments are crucial to meeting long-term financial commitments, and for institutions which must be able to pay out a certain level of income each year, investment planning must encompass both income and capital considerations.

It is also important for investors to be aware of the potential for negative publicity surrounding specific companies: in addition to the potential for a detrimental effect on share-price performance, investment in certain companies and industries may be regarded as inappropriate for some investors.

Many happy returns
Companies with strong prospects for dividend payments will be important for investors that must achieve a certain level of income each year and over the long-term. This is a significant issue for independent schools, which must battle low interest rates and continuing funding pressures throughout the sector, while working to maintain charitable status. Investment in companies with a firm, appropriate and transparent stance over ESG issues is an integral element of meeting long-term investment requirements despite the current climate of economic volatility. Investors should believe that responsible investment considerations remain an important indication of good management.

Amanda Young is the SRI officer at Newton Investment Management Limited. Newton Investment Management is authorised and regulated by the Financial Services Authority. The opinions expressed in this article are those of Newton Investment Management and should not be construed as investment advice.

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