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ESG Resilience: Is Green the New Gold?

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Relative resilience is found in the Environmental, Social and Governance (ESG) space during the Covid-19 crisis.

By Bernie Yeo

As the Covid-19 pandemic continues to dampen financial markets, funds with Environmental, Social and Governance (ESG) strategies have seen their fortunes rise.

In fact, major ESG funds have outperformed classic indices like the S&P 500 during the first weeks of the pandemic, and several ESG funds were able to soften the blow to loss in value as compared to standard non-ESG benchmarks.

This is bolstered by the fact that worldwide investors had poured US$45.6 bil into ESG funds in the first quarter of 2020 as compared to outflows of US$384.7 bil for the overall fund universe, according to research firm Morningstar.

To capitalise on this growing demand for ESG funds, Affin Hwang Asset Management Bhd recently unveiled the Affin Hwang World Series – Global Sustainability Fund (the fund). Launched on 14 September, it feeds into the Allianz Global Sustainability Fund (Target Fund).

As a feeder fund, it will invest at least 80% of its net asset value (NAV) into its collaborating partner’s Allianz Global Sustainability Fund with the remaining 20% of its NAV into money market instruments, deposits and/or cash. The Target Fund is a Luxembourg domiciled fund managed by Allianz Global Investors.

For context, ESG funds are portfolios of equities and/or bonds for which environmental, social and governance factors have been integrated into the investment process.

Changing demographics and trends

Affin Hwang Asset Management chief marketing & distribution officer Chan Ai Mei says the new ESG fund provides an avenue for investors to buy into global quality stocks with sustainable growth, whilst investing according to their own principles and beliefs.

“Changing demographics and trends, coupled with the unprecedented impact of the Covid-19 pandemic, have only accelerated the adoption of ESG by both businesses and the investing community in their decision-making.

“Our belief is that good governance ultimately leads to better financial performance, with industry research showing positive correlation between ESG and stronger returns over the long-term,” Chan adds.

The base currency of the fund is the US dollar. The fund is offered in four currency classes, namely USD Class, MYR-Hedged Class, SGD-Hedged Class and AUD Hedged-Class. The minimum investment amount is $5,000 for all listed currency classes.

Commenting on how the ESG space has fared in the aftermath of the coronavirus-related financial crisis, Allianz Global Sustainability Fund lead portfolio manager Paul Schofield says the pandemic in and of itself may not have huge issues on ESG investing. Rather, it may highlight some areas and downplay others.

“The trend for ESG has long been established and has been increasing year on year. ESG is just one tool in the toolbox that investors may use when analysing companies. We do not believe Covid-19 will change that; the trend was already in place and it is only going one way,” he tells Smart Investor.

“I have been told again and again by people on the other side of the table that ‘ESG is a bull market phenomenon’ and ‘no one will care when markets are under stress’. Hence, the year 2020 has certainly been a good opportunity to test those theories!”

 

Shifting the focus to ESG

Despite the existing trends surrounding ESG investing, there is no doubt that the focus has shifted a little in the face of the pandemic.

According to Schofield, the governance element of ESG was always the easiest one to talk about, as everyone understood this and was  comfortable that good corporate governance is a ‘good thing’.

However, in the past few years, the clear focus of ESG was the ‘E’ – the environmental benefits. In particular, climate change was the area that clients had a particular connection with. The ‘S’ – the social part of the equation – has always been the difficult one to discuss with people, and the pandemic has helped to highlight some of the social factors a little more, he adds.

“The need to get the economy back and firing means working conditions, for example, will need to be managed closely all around the world. Companies will have to convince its employees, trade unions and regulators that workers will be kept safe.

“This will be much discussed going forward, and topics will include healthcare, access to medicine, education, and health and safety – all of which were areas that were less discussed pre-pandemic,” Schofield explains.

 

The investment strategy

The Allianz Global Sustainability strategy invests in a diversified mix of companies on the global stock market that aims to generate long-term out-performance and a positive, measurable impact on society.

The investment process is a collaborative effort consisting of four stages: SRI Ratings; Idea Generation; Team Stock Selection; and Portfolio Construction.

The strategy takes a ‘Best in Class’ approach to SRI, seeking to own companies which outperform sector peers on ESG criteria. ESG performance is assessed using AllianzGI’s proprietary SRI Ratings model.

The strategy also aims to avoid stocks with reputational risks, excluding stocks with significant revenues from coal, tobacco, alcohol, weapons, gambling and/or pornography.

The model ranks stocks as Best in Class, Average or Worst in Class. Thereafter, using bottom-up fundamental analysis, the portfolio managers construct a concentrated, diversified and long-only portfolio of c.50 stocks with superior financial and ESG performance.

The team analyses all potential investments from the bottom up, considering stocks in terms of their quality, growth and valuation characteristics. The focus is on high quality companies generating returns sustainably above the cost of capital, with a clear growth trajectory, on reasonable valuations.

These stocks tend to be excellent franchises, operating in sectors with low competitive intensity and high barriers to entry. The valuation discipline is based on reverse discounted cash-flow analysis.

“The strategy invests primarily (at least 75% of portfolios) in companies that are considered ‘Best in Class’ according to our SRI ratings. It can also invest up to 25% of the portfolio in ‘Average’ rated stocks that have demonstrated a commitment to improving ESG performance,” explains Schofield.

This flexibility incentivises the portfolio managers to engage with investee company managements to press for continued ESG improvements.

“We believe that superior ESG performance may ultimately translate into share price appreciation. As a result, this mechanism is an important source of alpha for the strategy, as well as positive, societal impact. The strategy cannot hold any worst-in-class rated names.”

 


This article was first published in the November-December 2020 issue of Smart Investor.

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