A widely read piece in The Times last week saw Serco boss Rupert Soames lamenting the tsunami of investors who are now demanding that ESG factors – that’s Environmental, Social and Governance – are a key consideration in their portfolios. They’re no longer obsessed with pure profits.
This, says Soames, is a phenomenon that has only emerged over the last couple of years and risks making it more costly for those companies engaged in what could be seen as “necessary evils” - such as running prisons or building tanks and warplanes – to go about their essential business.
I don’t agree. At CrowdX, an investing marketplace which demands ESG disclosures from all its participants, we think the opposite can be true.
For years, many have been investing blindly, with popular products like index trackers meaning that all stocks in a common basket can attract funding at the same price. As a result, valuations haven’t been dictated so much by the actions of a company itself but by the scarcity of supply of the stock. But we’re now moving into a more sophisticated environment. People understand that what their money does influences society as a whole, and with a rapidly growing range of ways in which to invest at a granular level, investors can pick and choose as they please.
Whilst Soames suggested that this quest for ESG will make it more expensive for some to access capital, by many accounts this conundrum can be viewed with much more clarity if it is turned on its head. A more objective stance would be that this drive to responsible investing will make funding cheaper for those who look beyond simple profitability metrics - and as a result ensure their proposition appeals to the widest range of investors.
Soames singled out the incarceration of criminals as one touch point. Yet we know from the success of The Peterborough Bond – the world’s first social impact bond - that programs to reduce reoffending, whilst expensive in the short term, deliver positive outcomes in the long term. So why not adjust the metrics to ensure those running prisons can benefit from bigger picture thinking would shift the investment case, both on a financial and social impact level?
The topic of defence is rather harder to tackle – it’s difficult to price the positive social impact of a weapon of war - but let’s not forget there’s already a compact between the state and these industries. And it’s one that is structured to always offer a sensible financial return as it doesn’t truly operate as a competitive market. Ultimately, once political and security issues are taken into account, there are limited choices for the Ministry of Defence when they want a new fleet of fighter planes or a nuclear submarine. We can all agree that even for a hefty discount, they’re not going to be buying this kit from China.
If anything, the farce lies with the way some big companies have positioned themselves to take advantage of highly automated ESG rating systems and on this point Soames certainly has legitimate cause for concern. Behaving better is to be applauded and it’s now commonplace to find investor relations channels shouting about their eco-friendly achievements at the top of a results statement rather than this being consigned to a footnote. However, it will be a puzzle for many to understand how a multinational, London-listed tobacco company has one of the highest scores out there. What this means is that if you invest in an ESG tracker, the chances are you’re going to have someone selling highly addictive products in your portfolio as a result.
Closer scrutiny is necessary here and those fund managers – or even retail investors - who are taking a more hands on approach to assessing a company’s true impact are clearly ahead of the curve.
However, to suggest we get to a point where some companies will become uninvestable is simply disingenuous. Investors now have unparalleled choice when it comes to what they do with their money and – as a consequence – will be able to demand a premium should they choose to invest in the less palatable options.
Mike McCudden is the CEO of CrowdX - the new capital market for privately held businesses. www.crowdx.co.uk