Article 4 March, 2022

ESG investing – the right way?

Everyone is talking about ESG in 2022. However, is the investment industry’s current approach fit for purpose?

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The investment industry’s current ESG approach has been used now for over a decade, and focuses mostly on exclusions, best-in-class, or well-regarded ESG stocks. But we are facing a climate emergency and, in our view, the world is not going to achieve its sustainability goals if we carry on with this approach.

In a couple of ways, the approach the industry has been taking so far is lacking in foresight. Firstly, refusing to invest in polluting businesses whose products we use in everyday life seems somewhat hypocritical (we all want to live in glass and cement houses and travel to go on holiday), but secondly, and perhaps worse, starving companies of capital when they urgently need to significantly invest in order to decarbonise is counter-productive. When all said and done, the environment does not care what your ESG rating is, it only cares about how much carbon we are emitting into the atmosphere as a society.

Instead, we think that it is far better to take an activity, industry, or company that’s highly emitting or polluting, and help them to decarbonise. We’re doing this by investing in what we call ‘improvers’ or ‘enablers’. ‘Improvers’ are those companies with a high carbon footprint but who are on track to, or have the capability to, reach net zero. When you approach ESG from this perspective of improvement, it leads you towards buying out-of-favour companies which can have some very different outcomes to a lot of sustainable funds today. ‘Enablers’ are those companies which are producing the kit to allow others to decarbonise. This simple philosophical insight is central to our approach to ESG investing.

If you look at the market today, there is a large group of companies which have been regarded as un-investable by many market participants. However, we engage with companies who are leading on the facilitation of decarbonisation, or ones that aren’t doing so well, and support them to improve. We believe this has a much more positive real-world impact. We, as investors, are not going to facilitate industries like cement, steel and power production to decarbonise if we starve them of capital – but importantly, we’re also prepared to not invest in, or to disinvest from, companies who don’t show progress. This is a genuine difference we can make to drive change as investors.

If we’re right – if sustainability is a positive driver and these companies therefore re-rate – this is an additional source of potential alpha. This is an opportunity set that’s expanded in recent years, and something we’re really trying to exploit for the benefit of our clients - taking sustainability seriously whilst delivering strong investment returns. As counter intuitive as it may seem, we view ESG investing as the biggest contrarian opportunity of our careers.

The information in this article has been prepared and issued by River and Mercantile Asset Management LLP (trading as “River and Mercantile” and “River and Mercantile Asset Management”) registered in England and Wales under Company No. OC317647, with its registered office at 30 Coleman Street, London EC2R 5AL.

River and Mercantile Asset Management LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference Number 453087) and is registered with the US Securities and Exchange Commission as an Investment Adviser under the Investment Advisers Act of 1940.

This article is directed at professional clients. The information in this article should not be relied on or form the basis of any investment decision.

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