Looking beyond ESG
Integrating non-financial factors into stock decision-making is now becoming crucial to understanding the potential risks to a company from environmental, social and governance considerations (ESG). In today’s world, this is nothing new and is often the starting point for strategies that integrate sustainability into their decision making.
We take a slightly different approach. That’s because we believe you now have to look beyond ESG to consider climate change factors, which pose real long-term risks to companies, industries and countries in which they operate.
We are seeing positive change
We believe a cultural shift is happening across corporate-UK to address challenges around ESG and climate risk. As a UK Equity team, we focus on the long-term sustainability of the businesses in which we invest. When we conduct our research on companies, this involves an important question: Is the company management team alert to environmental stewardship issues and are they addressing them effectively?
In our experience of looking at long term sustainability, the alertness and sensitivity of senior executives to such issues is an important indicator of risk in a business.
It starts at the top
The question of management alertness is an important one. Many large companies have become adept at managing their sustainability scores by having policies and reports on everything. This is not especially helpful as a portfolio manager. This is why, as a UK equity team, we focus our attention on finding company management teams that are fully engaged on the topic of environmental and social stewardship. Integrating these issues into the fundamental fabric of business decision making is where great management teams distinguish themselves from merely good management teams.
It does not stop there: from an external investor’s perspective, it’s still important to track the management team’s ability to find solutions to these issues and asking that important question – ‘Are they addressing them effectively’?
Identifying the climate change risks
An important step in understanding the risks to companies is to recognise that climate change is multi-faceted. Rather than applying a simple equation, there are multiple risks related to climate and some may be less obvious. For example, we had identified one of our companies as having increasing flood risk as a result of rising sea levels. This would impact a key manufacturing site, potentially rendering it unusable in the long term. As we uncovered the facts, the land was owned freehold and had a significant amount of expensive equipment installed on site. This was going to be a difficult problem to solve: selling land and relocating high precision machinery whilst minimising business disruption was going to require a lot of management focus. The challenge became that much greater as the business was carrying debt, which required repayment, limiting the free cash flow available to fund such significant changes.
Identified early, steps could be taken over several years; however, in a few years, the company would be faced with less time to make changes and therefore, less flexibility.
Building a mosaic of information
It’s always worth remembering that the financial risks of a company are just as important as non-financial risks to get that full 360-degree view of each opportunity. In this respect, we adhere to our own determination of value when it comes to stock selection, which is the gap between a business’s quality and its price.
However, at the same time, we need to equip ourselves with new tools and new skillsets with which to identify potential problems, that look at ESG and climate change, and to engage with company management teams to ensure these future challenges are well managed and businesses remain a positive contributor to the communities in which they operate.
Important Information
All investment involves risks. Past performance of assets or indices are not a guarantee of future returns, and investors may lose the amount of their original investment. This communication may only be circulated to Eligible Counterparties and Professional Investors and should not be circulated to Retail Investors for whom it is not suitable.
Issued in the UK by Mirabaud Asset Management Limited which is authorised and regulated by the Financial Conduct Authority under firm reference number 122140
