Rather than seeing it as costs being driven down, we are seeing investors increasingly looking for investment managers to actively demonstrate that they add value
In our latest blog/interview we talk to Suresh Mistry, a Director at Alquity, about their approach to investing in Asia, Frontier and African Markets, whether there is room in the market for another investment management operation and if the only people who really benefit from outside investment are the corporates and not the people on the ground.
SL: Your ethos is built around using Environmental, Social and Governance Criteria; why do you believe in this approach, and is it something that is hard for people to buy into?
SM: Since we launched Alquity in 2009, we have fervently believed and espoused the values of responsible investment using Environmental, Social and Governance (ESG) criteria to assess companies alongside usual fundamental analysis. Our conviction was based on the seemingly logical perspective that companies who managed their responsibilities to the environment, their employees, their communities and were well governed would over the long term be successful and less prone to business shocks.
Unfortunately, this message often fell on deaf ears within the investment advisory world. I would be asked “where’s the proof?” or told that “my clients are only interested in making returns”, “this is for tree huggers”. It was often a lonely place to be.
Over the past year, we have seen some fundamental shifts in available evidence and attitudes that convince me that finally the investment industry is seeing the light and recognizing that rather than ridiculing responsible investment, if they move quickly enough they will become part of the in-crowd.
SL: You’ve indicated that there might be a change in attitudes; what are the reasons for this?
SM: Let me share the four main reasons why I expect 2016 to be the breakthrough year for responsible investing.
The pudding is bursting with proof
In 2015, a proliferation of studies from both asset managers and academia overwhelmingly confirmed that responsible investment over the long term delivers better, more stable returns. Even the paragons of good governance at Barclays recently announced that:
“We find evidence that a high ESG rating has been a source of modest incremental return in corporate bond portfolios. This is a surprising conclusion given that ESG investing is typically seen as a constraint…”
In addition and ironically they also conclude:
“It appears that Governance is the largest performance driver of the three of E, S and G.”
Let’s hope the powers that be at Barclays heed their own analysts advice. (Source: ftalphaville.ft.com)
The most conclusive assessment was a meta-analysis of over 2200 studies undertaken since the 1970s. Undertaken by the Universities of Reading and Hamburg in association with Deutsche Asset and Wealth Management concluded
“…we find that the business case for ESG investing is empirically well founded…Investing in ESG pays financially. Furthermore, we highlight that the positive ESG impact on CFP (Corporate Financial Performance) is stable over time”
Alquity’s own analysis in association with Cass Business School proved that the trajectory of a company’s ESG performance was an even greater predictor of CFP and hence investment returns. Confirming that our “Forward Looking ESG” approach is superior to existing consultant-driven ESG assessments.
It’s getting hotter
The recent Paris Climate Deal following the COP21 meeting finally saw the world accept responsibility for global warming through fossil fuel emissions with nearly 200 countries signing up. The agreement is only that and without binding targets relies on the integrity and resilience of governments to push through climate policies. The cynic in me feels that this is a tough ask (the fact that Donald Trump is so far ahead in the Republican nomination race anyone?) but hopefully the five yearly reviews will help bring countries into line and provide the peer pressure which has been lacking in the past. For investors, the Paris Agreement’ commits governments to making financial flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development (source: funds-europe.com). Polluters will be hit hard in the pocket and those companies who have already moved towards clean operations will benefit.
At Alquity, we have always considered our obligations to climate change as paramount. In addition, we also see the need to pull millions out of poverty through economic growth especially in emerging markets. We don’t believe full scale fossil fuel divestment is the solution but a collaboration between industry and government to create economic growth alongside reducing emissions.
Mirror, mirror on the wall, who’s the greediest of them all
At the beginning of 2015, Volkswagen was one of the most admired car manufacturers in the world. A stable of well known brands, leading models and burgeoning new markets like the US and Asia. Any investor who cared to look “under the bonnet” saw that the company had some serious governance issues but who cared as long as the profits rolled in. The need for more and faster profits drove levels of deceit rarely seen outside politics, sport and financial services. The cost; plain and simply human lives through higher pollution levels. Unlike a car crash, the invisible cost in lives was ‘justified” by the pursuit of market share and in Europe, regulators happily complied as lobbyist wined and dined them at Grand Prixes. Being sued by the US Environmental Protection Agency, the costs are likely to run into billions and this does not include the extensive damage to the brand.
VW had a great CSR programme and to the ESG “tourist” this would tick the box of a responsible investment. Corporates are now understanding that using CSR to paper over the cracks of poorly governed business will no longer do. The future will see custodial sentences alongside parachute payments for CEOs who pursue profit at all costs.
Investors are realizing that it is no longer an acceptable excuse to say that they “didn’t know” when the facts were available. ESG is no longer an option for fund managers but as fundamental as DCF or calculating the P/E ratio.
They don’t wear shoes…
There is an epochrifal story about a two shoes salesman who went to visit a new market. When they arrived and saw that no one was wearing any shoes, the first returned home glumly to report that there was no market for them. The second returned gleefully explaining how huge an opportunity he had discovered.
Unfortunately, many of the IFAs I have come across in my travels fall into the first category when I share the growing evidence that millennials (and women) are increasingly demanding that their investments are made responsibly as well as deliver returns. Returns at all costs are no longer excusable. I usually hear that “they have no money”, “they say that but really they only care about returns” or “most of my clients never ask about ethical investment”. These IFAs are also the ones most likely to sell their client high risk, illiquid investments because (cough, cough) they are asked for. The reality is that enlightened IFAs see responsible investment as an opportunity to engage and build a new, long term, loyal client base. By actively offering responsible investment they are not only snapping up the future HNWs in the world but also building their own brands. Restoring faith in the financial services sector is a long journey but embracing responsible investment is one step that will move the sector from below Estate Agents for levels of trust.
IFAs aren’t entirely to blame. Our recent survey found that over two thirds of IFAs lacked sufficient knowledge of responsible investment or available products. We’ve started the journey by launching an ESG programme (with CPD accreditation), we hope our peers follow suit in 2016.
In summary I see 2016 as the year of the “perfect storm” for responsible investment (no relation to climate change!). The confluence of the above factors should see responsible ESG-driven” investment become the norm and once again establish active stock selection as a value add against the rise of the passive “invest in everything” low cost model.
For Alquity, we need to keep pushing the boundaries and remain the fearless lone nut that will become the leader.
SL: Assuming we buy into this argument there is no doubt you have entered a market where costs are being driven down, and one that seems awash with investment managers all believing they are different. You obviously feel passionately about what you do but how/why do you feel that you can grow Alquity into a long term sustainable business?
SM: Rather than seeing it as costs being driven down, we are seeing investors increasingly looking for investment managers to actively demonstrate that they add value. For Alquity, this firstly means delivering attractive returns for investors through our bottom-up, non-benchmarked stock selection. In addition to decades of experience of investing in emerging markets, our investment teams meet all our stocks at least twice a year and travel extensively across their regions. Secondly, we have integrated “Forward Looking ESG” into our investment process. By understanding how the ESG performance of a business is changing over time, we are able to identify winners earlier and help increase long term returns. Finally by turning the ESG lens on ourselves through our Transforming Lives projects, we ensure we are contributing to the growth of the economies our investments are benefitting from. We call our approach the Alquity Virtuous Circle and it clearly differentiates us from our peers in a way that they would find extremely difficult to replicate.
SL: And finally the cynic in me feels that it is great that you invest in these “good” companies but is it not just about lining the pockets of corporates by bringing in foreign investors? What about the people on the ground, if you use this approach what do you do about making a difference to the people in these countries?
Glad you asked this as reducing inequality and providing equal opportunity for every individual sits at the heart of Alquity’s mission. That is why up to 25% of our revenues are donated through the Alquity Foundation to projects across the globe, providing some of the poorest people with a hand up. Over the last 5 years we have donated $650,000 and transformed over 23,000 lives in Africa, Asia and Latin America. We work with some of the best charities in the world on projects such as rural micro-finance, education and business training. By helping create the future consumers and employees for our stocks we improve their prospects and hence contribute to better returns. The donations come from our fees and not returns, so investors have the satisfaction of making a real difference to people’s lives whilst getting competitive returns.