A Responsible Investment programme is one that embeds known risks into its process. It is not a process that attempts to be ethical as its primary motive, nor is it solely motivated by “doing the right thing.” Instead, it stems from the belief that taking environmental, social and governance factors into account will enhance long-term returns by embracing secular opportunities and avoiding risks. Nevertheless, it is not an amoral approach either, hence Brunel’s strapline: “investing for a world worth living in”.
It is also necessary to say we categorically do not believe that following a thoughtful Responsible Investment policy comes at a financial cost. Indeed aligning portfolios with the Paris goal – of delivering a temperature increase well below 2◦C – is entirely consistent with securing long-term financial returns. We do not believe following such a path forces us to compromise financial returns. Instead, not taking into account such a financially material and known risk as climate change would arguably be a dereliction of fiduciary responsibility – a view reinforced by the regulators and the Bank of England. Our RI policy is not driven by a singular desire to “do the right thing,” as is sometimes presumed.
Take the traditional energy sector as an example. It is clear to us that, without credible transition plans and absent large positive changes in commodity prices, fossil fuel companies will be structurally challenged by:
When known externalities like carbon are priced appropriately, many businesses will be challenged – not just oil companies. This is not news, or even a controversial view, and the government’s recent levy of 35% on oil and gas companies is a taste of what is in store. What has sparked the recent rally in stock prices has been an underlying commodity rise, given events in Ukraine. Whilst possible, it is surely implausible that the oil price doubles again from these levels. Besides, investors seek to minimise uncertainty – and investing based on oil price forecasts only increases the uncertainty around company returns.
Like all those employing active strategies, we will undergo short-term periods of underperformance as the markets ebb and flow, but we believe that the consequences of economic transition are creating an inexorable trend – and aligning yourself as an investor will be a tail, not headwind, to financial returns.
Intertwined with these conversations is the undeniable recent reversal of fortunes for Growth-orientated sustainable funds. Despite the linkages, however, the two issues are fundamentally separate. Over the last decade, Value stocks (as epitomised by energy, material, and banks) have been serial financial underperformers. As such, investors following a responsible or sustainable strategy – and underweight these sectors – have been more aligned with Quality and Growth factors, thus enjoying very strong returns.
The recent and aggressive rise of inflation led the market to reduce the valuations of these stocks to compensate for the higher interest rate world we now live in. In many cases, the fundamentals of the stocks we own have improved, but share prices have understandably been weak. Thus converts to sustainable investing over the last 12-18 months have encountered only more difficult times, having missed the strong returns available in previous years. Understandably, they question whether there is a cost to investing in such a manner or indeed if they have missed the golden years! It’s a no to both. I answered the first fear above but, on the second, it is perhaps useful to look at Growth investing as a style and to track pattern of the returns it has provided over a longer time frame.
Academic research shows that since the 1950s in the US, approximately 5% of stocks have driven the net wealth creation. That is 1339 firms, and these firms have four things in common: rapid growth; strong cash accumulation; higher R&D spending; but also higher financial market drawdowns.
Amazon is a prime example (forgive the pun.) Between its launch in 1997 and 2020, it generated shareholder value of $865 billion. But even before 2022, investors suffered three drawdowns of over 50%, the largest being the 93% decline during the tech selloff. The lesson is that high-returning stocks come with higher volatility. Of course, it isn’t quite that simple. Many Growth stocks will never see profitability, which is why it’s important that our managers ensure that the potential growth is coming through in terms of revenue, that companies continue to reinvest for the future and that companies are financially robust.
As such, I think it is very plausible that the recent underperformance caused by the global polycrisis can be reversed over the coming years, as the economic transition begins to unfold, with growing support from governments, regulators and of course wider society. To complicate matters further, it’s too simplistic to say that sustainable investors are only in high-growth stocks. Indeed, in our funds we own many old industrial names, like chemical companies whose progress is crucial to a successful transition.
The trade-off question often posed about RI can often also miss the point that an RI policy isn’t just about what you don’t own, and certainly isn’t limited to listed equities. It is equally about what you do own across the entirety of your portfolio and should also focus on the opportunities created by the transition to a Net Zero world, which is arguably the largest single shift in our economic system since the industrial revolution. Some of the best risk-adjusted opportunities we can find today are in the in some way linked to the transition, not necessarily in the marquee operational renewable wind or solar assets, but further down the supply chain. It was often said during the gold rush, that the most reliable and sustainable profits were made not in panning gold, but in selling the picks and shovels!
Responsible Investment is also more than just the application of a view in choosing which assets to own; it is also how you exercise influence through that ownership, and how you interact with other market participants and actors, including the government and regulators. Our RI policy is based on a five-point plan that includes persuasion and policy advocacy. It also drives us to create products that are leading the way in RI terms.
But at Brunel’s core, our mission is to create products and portfolios to allow our partners to meet their needs, and we recognise that not everyone operates in the same way or at the same speed – and so not all portfolios will be right for everyone. In this context, valuable leadership is striving to realise our RI objectives and to meet all our clients’ ambitions. A good example is the creation of our Global High Alpha and Sustainable Equity portfolios. Another is our Cycle 2 infrastructure offering, in which we delivered both a renewable sleeve (before such entities were popular) and a generalist fund.
Finally, the point often overlooked is that, as the consequences of climate change manifest themselves, it is likely local authorities and governmental bodies that will be left to pick up the tab, whether that be flood defences, provision of housing for the displaced, or other public services. As such, the consequences for our partnership as an LGPS pool are manifold.
We will continue to prioritise our fiduciary duty as a pension pool, and we remain convinced that we can only do so by implementing a robust RI policy that is focused on the long term.