Has the shine come off ESG investments?
Soaring energy prices have caused ESG portfolios to underperform, but ESG-focused investing still has much merit - the trick is knowing how to modify your approach
Michelle Quah
RUSSIA’S invasion of Ukraine and the resulting spike in energy prices have not been favourable to environmental, social and governance or ESG-conscious investors - with the conflict leading to the underperformance of ESG portfolios, says Pictet Asset Management.
And yet, the shine hasn’t totally come off such investments - one needs to know where to look and how to structure one’s approach.
Underperforming ESG portfolios?
Global events this year have left their mark. Pictet’s recent Secular Outlook report notes that - with energy prices up 50 per cent from the start of the year - energy has been the best-performing sector by far; defence stocks have also done very well. Unsurprisingly, then, ESG funds have struggled to outperform, with the lowest proportion of them beating benchmark returns since 2015.
Nevertheless, the potential of ESG-focused investing remains.
“ESG is a long-term structural topic, and we believe it would transcend the short-term market challenges,” says Evelyn Yeo, head of Asia Investments, at Pictet Wealth Management Asia.
ESG investments are regarded as “secular”, as opposed to “cyclical”, in nature - their subjects are long-term events with conditions that persist, regardless of economic or cyclical developments - unlike, for example, consumer stocks, whose fortunes would be tied to economic fortunes.
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As Yeo points out, the challenges of climate change remain - she cites, as examples, the recent heat waves across Europe, the continuing melting of glaciers, and the persistent contamination of waters in certain parts of the world.
“These are topics that are very close to people’s lives - and livelihoods. So, while markets have suffered, and inflation has spiked due to the energy crisis, the focus on ESG will not abate.
“And we believe capital market participants, including financial institutions - especially Pictet - will put our money where our heart is, and strive to allocate capital towards the right cause.”
Clean energy
Pictet has identified a few areas that it believes could gather strength in the coming years and become a source of excess return - the first being clean or renewable energy.
While the Russia-Ukraine conflict has caused energy prices to surge and disrupted supply chains, it has also served to underscore the urgency of the ongoing green transition - not just in terms of halting climate change, but also in ensuring geopolitical energy independence and security.
In its Secular Outlook, Pictet predicts that, while Covid-19 pandemic supply constraints forced a shift back to fossil fuels, the efforts to build a greener and more sustainable economy will endure and even accelerate.
It believes the Russia-Ukraine conflict could add further momentum to the clean-energy transition, with the spike in energy prices forcing governments to invest more in energy security. Renewables would help diversify a country’s energy sources and reduce entrenched geopolitical risks.
Health
Meanwhile, the Covid-19 pandemic has created other opportunities in the ESG-investing space.
The human cost of the pandemic has seen governments and consumers pay greater attention to healthcare and wellbeing, Pictet said. And it expects companies that contribute to making healthcare systems more efficient, and those helping individuals lead healthier lives, will benefit from the change in society’s priorities.
It also noted a strengthened drive for equality - with the most vulnerable sections of society having borne the brunt of the pandemic.
These new priorities will feed through to expectations and actions for both the private and the public sector, the asset manager said. Companies with a strong social ethos, for instance, could reap reputational benefits.
“Social and health concerns will continue to be secular topics, more as a result of an ageing population in the developed world,” Yeo said. “These have investment implications, and it’s important for investors to consider companies in the healthcare sector (including those that make up the value chain, such as biotech, pharma, medtech, and healthcare services companies, for example), while being cautious about sectors that could be considered social ills.”
The unexpected
Investors should also look beyond the more “obvious” candidates, Yeo adds. Less-expected choices, such as oil and gas companies that are committed to transform their businesses, could also do well.
“They are at the crux of disruption - and it is no longer a question of if one should transform, it is a question of when. We can take our cues from the automobile industry, which, for the longest time, has been challenged by the likes of Tesla. This will be an interesting area to watch.”
But looking beyond the expected and navigating geopolitical changes means that investors will have to stay sharp - and modify their approach.
“The aspiration could remain,” Yeo says. “However, the approach would have to be more scientific, especially with the threat of greenwashing and some market participants jumping on the ESG bandwagon just to attract funds.”
She says that being scientific would require proper frameworks that start with the collection of reliable data, and a rigorous process to analyse and present the output meaningfully.
“Look beyond the superficial (and) dig deep into the financials of each company - for example, look at where its R&D (research and development) is spent, and know that not all greens are created equal. Understand the management’s motivation and direction - this is key.
“It is important not to chase after any particular short-term ‘hot’ theme. At Pictet, we always advocate seeking quality while adopting a sustainable long-term thinking mindset.”
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