Responsible investment

A delicate balance: ESG, sustainability and returns

When environmental, social and governance (ESG) funds were in their infancy, a common misconception was that investing responsibly involved some trade-off in performance.

Today there are thousands of studies available that dispel this myth. In fact, of 200 academic studies on the link between ESG and return, 88% indicated that companies with strong sustainability practices demonstrate better operational performance, ultimately translating into cash flows. In addition, 80% showed that strong sustainability practices have a positive influence on investment performance1.

However, while it is clear that investment managers who take ESG considerations into account have the potential to outperform, with the vast array of ESG funds now available it is important to look beneath the hood before investing. The chosen fund should closely align with an investor’s values, while also supporting their investment goals and desired outcomes.

The active versus passive debate

In selecting a sustainable investment, a first step many investors and their advisers take is to determine whether an active or passive approach is most appropriate.

While interest in passive sustainable investments continues to grow, we believe active management is a demonstrably better approach for investors seeking ESG integration in their investment portfolios.

An active strategy can afford investors a greater degree of control over their investments and allow them to align their views to those of the investment manager, rather than outsourcing everything to an index provider.

While an ESG benchmark may achieve the desired sustainable outcome, it may not be designed to explicitly avoid the uncompensated sources of risk that an active investment manager would seek to avoid.

As an active manager, we use proprietary data to gain a deeper understanding of companies in the investment universe and explicitly target both financial and non-financial outcomes, while constantly overseeing the portfolio’s active risk exposures and taking steps to address these where appropriate.

In the Sustainable Equity strategy, our aim is to build a portfolio with the potential to deliver long-run outperformance of the benchmark with lower total risk, or volatility, with better-than-benchmark sustainability features such as a higher ESG score and a lower carbon footprint.

Blending ESG and specific factors identifies sustainable investments

The next step for investors is often to analyse the available product set to find the right alignment with their own individual values and goals.

While some investors have an ethics -based approach to ESG investing, avoiding gambling stocks for example, others approach ESG as a way to evaluate long-term risks and opportunities and invest in companies that contribute positively to issues such as climate change and social justice.

AXA IM’s sustainable equity strategy is designed around three key elements – attractive fees, sustainability and financial performance. We seek to achieve the last two elements by blending proprietary quality and low volatility factors with in-house views on individual stock-level ESG information, carbon and water intensity data, while also applying AXA IM’s ESG Standards to our fund’s ranges.

We find that quality and ESG can often be viewed as different dimensions of the same theme – sustainability. High quality companies not only deliver superior earnings today but also have the potential to deliver sustainable earnings growth into the future.

When analysing the quality of a company, we look closely at the way it is managed – how it uses its assets and grows its earnings – as well as considering non-financial aspects of management, such as whether it has a diverse board.

Numerous studies have shown that diversity is important to the success of teams, as it fosters alternative viewpoints and challenges ‘group think’. Our research shows that diversity in management boards is linked to better current financial results and is also an indicator of the ability of a company to protect its future profitability2.

The second factor AXA IM looks at is volatility, which it could be argued also has a link to a company’s ESG credentials. Young, fast-growing companies, for example, may be more volatile. As they mature, however, businesses not only become more stable and predictable in terms of performance but are also able to do more for their employees and society.

There have been many instances of larger businesses using their size and presence to directly influence change. A notable one in recent times was Unilever3’s announcement of an initiative to ensure workers across its entire supply chain earn at least a living wage by 2030. The group will also spend US$2.4 billion globally with suppliers consisting of under-represented groups by 2025.

In seeking out companies that have advantages over their competitors, we believe it is essential to include this type of non-financial consideration in our investment decisions.

Walking the talk

Beyond investment approach and product offerings, investors and their advisers should also look at the bigger picture, to ensure the ESG manager is putting responsibility at the heart of its culture.

AXA IM, for example, is committed to sector and international initiatives related to the environment such as the UN Principles for Responsible Investment, the Institutional Investors Group on Climate Change and the Carbon Disclosure Project.

Recently, we were among the first asset managers to commit to bringing carbon emissions across all assets to a target-based net zero goal by 2050 or sooner, by joining the newly created Net Zero Asset Manager initiative.

We believe there is an urgent need now to accelerate the transition towards net zero emissions and as such will continue to work with our industry and regulators to drive meaningful environmental change.

AXA IM is also committed to a range of social initiatives. One of these is the AXA Hearts in Action program, which encourages employees to dedicate some of their time and know-how to charitable organisations focusing on education and social integration. Our employees are currently engaged in long-term partnerships with 17 organisations based in 10 countries. We also donate 5% of management fees on our impact funds to projects aimed at developing solutions with a societal impact.

In conclusion, with an increasing amount of capital being committed to ESG, investors not only need to consider the product in which they invest but should analyse the people behind the process. A principled ESG manager will not only perform in line with expectations but will show ongoing commitment to embracing sustainability in their own operations.

[1] From the stockholder to the stakeholder: How sustainability can drive financial outperformance, University of Oxford and Arabesque Partners, 2015

[2] Does diversity provide a profitability moat? AXA IM, 2018

[3] Companies mentioned are for illustrative purposes only, and not to be considered as investment advice or recommendation.

Risk factors with this strategy:

Company specific risk: There may be instances where a company will fall in price (or rise in price) because of company specific factors (for example, where a company’s major product is subject to a product recall).

Highly volatile markets: The prices of financial instruments in which the strategy may be invested can be highly volatile.

Market risk: Changes in legal and economic policy, political events, technology failure, economic cycles, investor sentiment and social climate can all directly or indirectly create an environment that may influence (negatively or positively) the value of your investment in the strategy. In addition, a downward move in the general level of the financial markets can have a negative influence on the strategy.

 

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