As stockpicking investors, we spend much of our time buried in balance sheets and on company visits. The financial health of individual companies is our bread and butter.
But even for fundamental, bottom-up investors, there is much more to an investment decision than the financial factors alone.
For us, the biggest aspect of this is what we refer to as sustainability. By this, we mean any non-financial factors that could have an impact on an investment’s performance. This includes all the concerns covered by environmental, social and governance analysis – such as environmental performance, adherence to regulations, quality of management, corporate governance, accountability to shareholders, treatment of employees and support of communities.
By integrating this analysis into a fundamental research process, we can attempt to achieve a more accurate assessment of long-term corporate value than we could derive from financial information alone.
We don’t do this primarily out of the goodness of our hearts but to benefit our clients. Happily, though, our clients’ interests and the long-term interests of companies, communities and ecosystems tend to go hand in hand.
Environmental considerations provide a good example here. In the short term, a company that integrates environmentally friendly measures in its operations is likely to experience reduced profits as environmental precautions cost money. But over the long term, such a company may well prove to be more profitable than a less green competitor. Why? Because as environmental regulation increases, the early adopters will be better placed to meet regulatory require-ments than their competitors, who will have to spend heavily to meet new regulations at short notice.
Similarly, a poorly governed company might look attractive for any number of reasons in the short term. But in the longer term, the lack of the safeguards that good governance entails is likely to lead to problems. And, however deep those problems might be buried, our experience suggests that they will surface sooner or later.
So any sustainable investment case must be built upon good corporate governance. Last year’s accounting scandals at a number of US-listed Chinese firms underscore this point.
Digging deep into corporate behaviour and the structures that support it may take time and effort but the security that an investor gains from having undertaken an exhaustive investigation is invaluable.
Aside from the ESG factors, another important aspect of sustainable investment involves harnessing social, developmental and economic trends that are set to last.
As the events of 2011 demonstrated only too clearly, these are dangerous times in which to attempt to play any developments that are unlikely to endure.
Whatever the short-term attractions of a given stock are, they offer little protection against the macroeconomic-driven volatility that has dominated equity markets since the financial crisis broke.
In contrast, the opportunities arising from genuinely long-term change are likely to be both material and lasting.
Demographics play a vital role in this. The demographic patterns of the largest emerging markets – the Bric nations – are very different, with important implications for how social, business and consumption-related trends will play out.
Today, for instance, half of India’s population is under 25. By 2030, the median age in India will be 31 – whereas China, thanks to its decades-old one-child policy, now has an aging population and will have a median age of 42 in 2030. By that time, China will have to face up to the effects of an older population with a relatively smaller base of workers to support it. In contrast, around 70 per cent of India’s population will be between 15 and 64 – working age, in other words.
These trends have different implications for the whole spectrum of industries; the opportunities and challenges for the healthcare sector that will arise from an aging population in China are perhaps the most obvious example. But the underlying demographic patterns are trends that no long-sighted investor can afford to ignore.
As emerging-market consumers become increasingly affluent, changing patterns in consumption are another key area to consider. Equally important are the issues of urbanisation, natural resources, climate change and access to credit.
Many of these factors are interconnected. For example, an increasingly consumer-oriented society tends to drive urbanisation, which in turn drives the utilisation of resources, which has an impact on climate change, which is resulting in tighter regulations – regulations that ultimately affect corporate costs and necessitate access to credit. So it is essential to take a holistic approach when considering sustainability – one which takes into account multiple factors and integrates them into a disciplined, fundamental research process.
These issues of sustainability are of global importance but they are especially relevant in the emerging markets, given their rapid development and the challenges entailed by limited resources and changing demographics.
A common criticism of emerging-market companies centres on their lack of disclosure when it comes to ESG matters. To an extent, this is true. A large amount of due diligence and patient research is often required to extract the relevant ESG data. But as local legislation evolves and active investors’ engagement with management on sustainability issues increases, many companies are producing good quality sustainability reports.
In Brazil, for example, the creation of the Novo Mercado (a set of stockmarket listing requirements demanding improved corporate disclosure by companies) has resulted in an increasing number of Brazilian companies complying with a much more rigid set of corporate governance rules.
Sustainable investment does not guarantee enhanced returns but a company’s sustainability can be a strong lead indicator of management quality and long-term financial performance.
By incorporating sustainability into our investment process, we are acknowledging that companies are operating in an increasingly changing and challenging world.
In doing so, we hope to uncover hidden risks as well as pinpoint opportunities and while our investors’ interests are paramount in this, the beneficial behaviours that sustainable investment encourages allow us to seek a win/win outcome of positive financial and societal returns.
Andrew Ness is speaking at the Alpha Generators 2012 roadshows