Three 'Ps' that make your sustainable investing the ‘real deal’

The term “sustainability” is often over-used in investing and has become a catch-all for a number of different approaches.

We consider three elements to be crucial:

1. Purpose – referring to what we think sustainable investing can achieve in terms of investment returns and influencing company behaviour
2. People – assessing sustainability is often a judgement call and can’t be boiled down to scores or ratings provided by a third party
3. Process – bringing purpose and people together to create a repeatable process that evolves and improves over time

Investing with a purpose

We believe the purpose of sustainable investing is to have a positive impact on society and corporate behaviour, while at the same time helping clients to achieve their investment goals. It means choosing to allocate our capital to companies that are either already being run in a sustainable fashion, or are in transition, or are on their way to improving their sustainability profile.

In our view, sustainability is an integral element of investing rather than a trade-off.

It sets minimum standards of conduct for an investee company. If a company is engaging in activities or behaviour that are causing serious harm to society then there is no valuation, however attractive, that can compensate for that negative impact. But we don’t think drawing a line in the sand like this is detrimental to investment returns.

Why do we think this? Ultimately, what we’re looking for are sustainable business models. This is based on answers to questions such as: can they grow their business? Can they improve their profit margins? And are they at risk of regulatory fines, or of falling behind their competitors?

For example, if a company is not adequately considering its impact on the environment, then it risks being fined by regulators and suffering reputational damage among its customers. If it is underpaying its employees, then it may have problems with staff retention and profit margins could be lower in future if wages need to rise. By contrast, companies who consider their impact on stakeholders – such as employees or the environment – are better placed to avoid such risks.

It’s important to add that we’re not simply investing in the most sustainable companies today, regardless of their share price prospects. We’re looking for mispriced opportunities, where the current share price doesn’t capture the company’s potential. Identifying sustainability risks, and potential for improvement, is a crucial element of trying to achieve higher investment returns.

People-powered analysis

Assessing sustainability risks and opportunities often comes down to judgement. This is where the support of our team of equity analysts is invaluable.

We divide our consideration of a company’s impact into three categories:

1. What a company does, in terms of the products or services it provides
2. What costs or benefits the company imposes on society (which may not be immediately obvious). At Schroders, we have our SustainEx investment tool which helps us assess this
3. How the company behaves towards its employees, suppliers and other stakeholders. We have another investment tool – CONTEXT – which allows us to assess this and compare the company to its peers

Importantly, we make these assessments hand-in-hand with our usual financial analysis. Rather than dealing solely with a company’s executive management team, engaging on sustainability issues across the company can often give a clearer picture of the operational side of a business.

Instead of relying on blunt tools such as scores provided by third parties, the conversations we and the analysts have with businesses enable us to build a nuanced, forward-looking picture. As sustainability grows in importance, these conversations are increasingly a partnership whereby both we and the businesses we engage with are looking at ways to improve. The questions we ask can help drive progress.

For example, a company might not have sustainable practices, but needs help on the best way to show evidence of this. Other companies – especially smaller firms – may need guidance on what is best practice.

We sometimes encounter situations where a company is not following best practice on a sustainability issue. But rather than resulting in an automatic ‘red light’, our analysts can engage with the company to discover if there is a valid reason for any shortcomings. We consider this ability to discuss grey areas in sustainability as essential – it gets missed by just relying on third-party ratings. We also often find that a conversation about sustainability issues with one business can aid our understanding of similar issues facing a different firm.

A repeatable process

We combine our purpose, tools and insights into a process for assessing sustainability that is forward-looking, repeatable and valid across different sectors.

Further, the process works whether we are looking at lowly-valued stocks or ’quality growth’ areas of the market, which reflect companies that tend to have consistent returns – regarded as a mark of sustainability. Yet cheaply-valued companies can also be sustainable investments.

We believe sustainability standards will rise over time; what’s best practice today may be tomorrow’s bare minimum. Our process has the ability to evolve and improve, enabling us to remain focused on the future along with the best mispriced opportunities we can find.

Click here to learn more about ESG integration as well as the tools that can help evaluate how sustainable portfolios are.
 

IMPORTANT INFORMATION
Investment involves risks. This material is issued by Schroder Investment Management (Hong Kong) Limited and has not been reviewed by the SFC.