ESG stands for Environmental, Social, and Governance and, according to PWC, investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities.
With Western countries having moved fast to isolate Russia in the wake of the war in Ukraine, energy security and the green economy have risen even higher up the agenda than they were before. In the short term, the sanctions imposed against Russia and disruptions to supply have helped to spur higher oil and gas prices. However, longer term, it seems likely that we’ll see an accelerated move towards green or renewable energy sources.
So, what does this mean for markets and investors? In the immediate term, many European countries and Germany in particular, have been heavily reliant on Russia for gas. Germany, one of the European countries most impacted by climate change, is expected to accelerate its move towards renewables to decrease its dependence on Russian energy.
Although European countries aligned with or sympathetic to NATO will want to become less reliant on Russia as a prolonged war turns it into a pariah state, the transition towards greener energy will take many years. Indeed, we’re seeing delays in some green projects as nations shift spending towards defence and focus on fossil fuel projects – oil, coal, fracking and tar sands – to fill current supply shortfalls.
But in the medium and longer term, we’ll see nations ramp up their investments in green energy sources. With oil prices around $100 per barrel, the economics of green projects look more attractive than at the $70 per barrel level we saw in December 2021. This means there is a stronger investment case and less of a need for governments to offer subsidies to get projects off the ground.
As a side note, we may also see an increased shift to pragmatism about how we transition to greener energy while minimising the impact on industry. With the European Commission awarding nuclear power and natural gas a green label, these weather-independent options are likely to remain a key part of the energy mix, particularly for baseload supply.
The growing focus on ESG factors
The responses by various governments to the Russian invasion of Ukraine dovetail with the growing focus we see on ESG factors among retail and institutional investors and are likely to lead to further questions being asked in this regard.
Although we have not specifically focused on ESG factors in our investment philosophy, our quality-style bias means that most of the funds we have selected are made up of companies that have strong ESG credentials.
One example of such a fund is the Fundsmith Equity Fund. The average year of inception for the 29 companies in the portfolio is 1927, even though the fund includes companies such as Meta, Microsoft and PayPal that were established far more recently. Companies that have existed for nearly 100 years have proven their sustainability.
In addition, to specifically accommodate investors for whom ESG and sustainability are particularly important, Fundsmith also has a Sustainable Fund, which explicitly excludes the following sectors:
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Importantly, the only sectors among this group that are represented in the main Equity Fund are tobacco and brewers, distillers & vintners. Companies in the other sectors do not meet Fundsmith’s quality criteria. The top 10 companies in the Sustainable Fund are all included in the Equity Fund and only Philip Morris (tobacco) is included in the Top 10 of the main Equity Fund, but not in the Sustainable Fund.
In addition to meeting the Sustainable criteria, the exclusion of the Oil, Gas and Consumer Fuels, Metals and Mining, as well as the Gas and Electric Utilities, means that the qualifying companies also tend to meet the Environmental requirements of the ESG classification.
While we at Dynasty avoid thematic investments, such as funds focussed purely on ESG criteria (because they rarely deliver consistent outperformance over time as well as the fact that the mandates of thematic funds are restrictive by their very nature), the Fundsmith example above with its broader mandate, as well as the Ninety One Global Franchise Fund, illustrate that quality is often a proxy for ESG. Well-run companies tend to be attuned to ESG risks.
However, we also understand that some clients may wish to avoid investing in companies that are not aligned with more stringent ESG values. For that reason, we offer access to restricted mandates like the Ninety One Global Environment Fund and the Fundsmith Sustainable Fund, with the Ninety One Fund being our preferred alternative for this purpose.
In summary
We conclude that the war in the Ukraine will provide impetus for ESG criteria, but that quality global businesses are already reflecting many of these characteristics.