Not another article about environmental, social and governance themes!
Well, this one will be a bit different.
ESG ratings have taken a central position in describing funds in recent years.
To enable a standardised approach, there has been much use of scoring and data.
Many companies object to the way they are scored and professional investors are often aware of nuances and make allowance for them.
Furthermore, fundamental analysis of companies allows any stock-picker to adjust valuations according to the materiality of ESG factors – does it really make that much difference to the valuation of a bank whether it uses more or less paper or water?
On the other hand, for a retailer, treating staff and suppliers well is vital to long-term success.
ESG scoring processes are deliberately universal and so make few allowances for regional differences. In my opinion, successful stock selection is quite the other way – you do better if you do appreciate and evaluate regional differences.
Starting with the multi-faceted social area, this looks at how a company treats staff, suppliers and the communities in which it operates.
Japan is, I think, a place where companies have always taken these matters very seriously, and there is little doubt they view their responsibilities to employees quite differently from UK or US companies.
They get some credit for this from ESG scores, but often a lower valuation as overseas shareholders feel their interests are put below those of employees – they are right, of course.
Treatment of shareholders has, in a variety of ways, been something that has held back Japan’s equity market for years, though the political winds there have shifted more recently, which may prompt changes.
Global standards
Environmental standards and risks have been very different around the world, again with Japan setting very high standards, and emerging markets somewhat lower.
In recent years these standards have been rising everywhere and converging. Significantly for investors, fines for pollution have become higher in emerging markets.
BP was fined billions for the Deepwater Horizon oil spill.
This year BHP and Vale have been ordered to pay hefty damages for the collapse of the Samarco dam in Brazil, though this is still being appealed.
By the way, £90m is the largest fine ever given out by the UK environment agency – to a water company of course.
As environmental costs rise in emerging markets and as mining companies increasingly find their best new deposits in less explored territories, operating costs and insurance are bound to rise.
Investing in a company that operates mines in emerging market economies is an endeavour that has always come with idiosyncratic risks, ESG may add another layer to that in future.
But it is in the area of corporate governance where regional differences persist in ways that are most likely to affect investment returns.
I was thinking the other day about two large companies whose share prices have performed badly over the past five years: the Prudential in the UK has seen its share price fall to £6.70 from £12, while in the US Zimmer Biomet shares have fallen to $114 from $138 – a smaller drop but against a US market that has performed much better.
