Neglect ESG at your peril

With the growing awareness of the climate crisis, some shares are viewed as more vulnerable. More investors are sensitive about owning them.

3 minute read

As a UK equity income fund manager, Chris Murphy has two priorities for his investors: consistent yield and long-term capital growth. This means finding companies with long-term business models and strategic barriers to entry, so they can stand the test of time, sustaining and growing over many years.

Consumers are increasingly ethical in the way they shop. Companies that neglect ESG risks could face a perfect storm of regulatory fines, consumer boycotts and financial disruption

To do this increasingly requires an analysis of environmental, social and governance factors. Issues such as climate change and labour practices have become headline news in recent years. From Greta Thunberg to Extinction Rebellion, there is increasing pressure on policymakers, companies and asset managers to act. There are also sound economic reasons: consumers are increasingly ethical in the way they shop. Companies that neglect ESG risks could face a perfect storm of regulatory fines, consumer boycotts and financial disruption.

Such pressures influence share prices. Murphy, who manages the Aviva Investors UK Listed Equity Income Fund says: “With the growing awareness of the climate crisis, some shares are viewed as more vulnerable. More investors are sensitive about owning them.” As more investors work within an ESG framework, there are fewer buyers for companies that score poorly on ESG factors.

Sustainability and an income mandate haven’t always been easy bedfellows

With this in mind, Murphy says ESG analysis is integral to finding companies that are well run and sustainable: “We want companies in which we invest to be efficient. If we’re investing in a mining company, of course we want it to have a good health and safety record. To do otherwise would introduce considerable risks. For us, sustainability is part and parcel of a good business model. It reduces the risk of stocks blowing up, or long-term structural weakness. We always want to invest in best-in-class companies.”

Sustainability and an income mandate haven’t always been easy bedfellows, with much of the income from the UK market coming from large oil companies. Murphy takes an unconstrained, non-benchmark approach and has been consistently underweight this part of the market. That said, he emphasises that engagement is vital in encouraging these companies to do the right thing. He points out that these companies are now leading the way in electrification.

He says: “The fund currently yields around 4.75% (as at 31 Jan 2020). This is a premium to the market and we are not forced to own any business on yield grounds. There are plenty of places to find income. There are plenty of opportunities at the bottom end of the FTSE 100 for example.”  Today he holds as much in Greencoat Wind Farms as he does in BP. 

ESG is firmly embedded in the heritage of Aviva Investors and the wider Aviva group. There is an in-house global responsible investment team, with whom Murphy works closely. It has 22 members in a range of roles. “They may work on specific projects or do high-level sector work. Others will be focused on governance and engagement. They will come to our meetings with companies to discuss specific issues,” he says.

Those companies with better management will be ahead. This is not a fad and it’s not going away so companies need to manage it

This ensures he has all the ESG data he needs at his fingertips. He can understand if a business is deteriorating or improving and is quickly alerted to potential problems at individual companies. While he is not forced to sell, it means he can look at why a company might be having problems.

It can also help direct him to companies with stronger prospects. He says: “Those companies with better management will be ahead. This is not a fad and it’s not going away so companies need to manage it. Look at companies such as National Grid. If we move into sustainable storage through batteries, there will be more investment in the grid and network. In this environment, National Grid can deliver long-term steady returns.”

There are other challenges facing UK investors, including the political backdrop. Murphy has moved back into a number of UK companies in recent months, including Ibstock, DFS and Tesco, but this is on valuation grounds, not because he was taking a view on the election. “These are simply cheap and attractive assets.”

We own DFS, simply because it is tough to buy a sofa online. You need to sit on it to make an informed decision

He aims not to be exposed to a binary outcome. “If you’re right, you may look like a hero, but if you’re wrong, it’s very painful. However, the continued outflows from the UK market have left UK equities on a yield of around 4.5% and a price-toearnings ratio below the long-term average. There is a case that the UK is now the cheapest developed market.” Murphy notes M&A activity is picking up, which should help support the UK market from here.

There are risks, however. There have been a number of high-profile dividend cuts, including Vodafone. There are also well-documented problems on the high street. “From a retail standpoint, if a company can’t compete in the online environment, they won’t survive. We own DFS, simply because it is tough to buy a sofa online. You need to sit on it to make an informed decision.” Judicious stock-picking is key, he says, and a flexible approach to avoid these under-pressure businesses. 

“Regardless of the backdrop, we are long-term investors, looking for companies generating strong cash flow and growing dividends. We’re not making sudden decisions. It’s in our DNA. We’re here to support good business and responsible capitalism,” he adds.

This article originally appeared on Adviser Hub.

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Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL) as at 28 February 2020 Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This material is not a recommendation to sell or purchase any investment.

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