Article 5 October, 2022

Why investors should not forget about ESG during a downturn

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The pound tumbles, inflation surges and the Ukraine war persists. Whilst attempting to navigate such challenging markets, it is vital that investors do not succumb to the “danger that environment falls down the agenda” (Nicolai Tangen, Head of Norway’s $1.2tn oil fund[1]) and continue to note the importance of considering ESG (environment, social and governance) factors in the investment decision making process.

One of the fundamental reasons why investors consider ESG factors in investment analysis is that material ESG factors have an impact on a company’s bottom line. This has been highlighted by many researchers who have shown that ESG integration can lead to reduced costs and increased efficiencies[2]. With current market turbulence resulting in increased cost pressures on companies’ financials, considering material ESG factors allows investors to identify high-risk companies that will be less resilient to shocks. Additionally, the ‘G’ aspect of ESG is critical in a crisis as businesses with good corporate governance and high-quality management have more chance of navigating external shocks due to effective decision-making.

Reputational and regulatory risks experienced by companies are heightened during a downturn, particularly when they do not consider their ESG credentials. During challenging times, corporates tend to be observed with heightened scrutiny by investors, regulators and governments alike. For example, material controversies such as health and safety under the ‘S’ pillar can have serious consequences for stakeholders’ perception of the company with ramifications exacerbated under watchful eyes. Additionally, governments have started to issue regulations to mandate companies’ climate transition and the financial consequences of not abiding by these will only create more pressures. On the other side, government financial incentivisation aligned to the climate transition, such as tax incentives indicated in the figure below, can still provide opportunities for companies to manage and enable the transition.Source: Centre for Climate and Energy Solutions, 2021[3]

Should ESG fall down investors’ agendas during a downturn they risk missing investment opportunities in sustainability enablers that benefit from continued CAPEX spend during this period. Stocks such as NKT (pioneer in the cable industry) which is beneficiary to the offshore wind boom to secure energy supplies following the Russian-Ukraine war[4] or Metso Outotec and Weir which are providing decarbonisation solutions for the mining industry, continue to be ESG winners and present strong investment opportunities. Portfolio manager William Lough will expand on this point in an upcoming thought piece.

Sustainability presents long-term risks and opportunities, such as the net zero by 2050 trajectory which represents a transition over more than 25 years. Considering the ESG credentials of our companies and portfolios must prevail as we experience market peaks and troughs during these medium to long-term transitions. Additionally, we believe consistently considering the ESG factors financially material to individual companies is in line with our fiduciary duties as investors by continuing to generate attractive risk-adjusted returns for clients and have a longer-term positive impact on environment and society.

It is therefore our duty as investors not to forget about ESG during times of economic and geopolitical deterioration as it presents an important tool to help identify investment risks and opportunities.

[1] Norway oil fund warns of ‘danger’ that environment falls down agenda | Financial Times (ft.com)

[2] For example: ‘Sustainable Investing: Establishing Long-Term Value’, Fultun, Kahn and Sharples https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2222740

[3] Cap and Trade Basics - Center for Climate and Energy SolutionsCenter for Climate and Energy Solutions (c2es.org)

[4] Offshore wind primed to benefit from investment boom and energy transition (cityam.com)

 

 

This information has been prepared and issued by River and Mercantile Asset Management LLP (trading as “River and Mercantile” and “River and Mercantile Asset Management”). River and Mercantile Asset Management LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference Number 453087).
The value of investments and any income generated may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Past performance is not a reliable guide to future results. Changes in exchange rates may have an adverse effect on the value, price or income of investments.
Please note that individual securities named in this article may be held by the Portfolio Manager or persons closely associated with them and/or other members of the Investment Team personally for their own accounts. The interests of clients are protected by operation of a conflicts of interest policy and associated systems and controls which prevent personal dealing in situations which would lead to any detriment to a client.

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