How ESG investing can deliver on both performance and principles

Investors are increasingly using environmental, social and governance (ESG) ratings to screen investments, so portfolios can proactively protect people and the planet. The COVID-19 pandemic has accelerated this trend in ethical investing. While the world has been turned upside down by the virus, so too has the outlook of many investors. People are now more aware of long-term sustainability risks. But ESG ratings are not just being used to analyse ethics, they can also work out if a company is worth investing in.

ESG data gives a good indication of the operational quality of a business, and how well it’s positioned to negotiate the risks and opportunities of future cash generation that ESG considerations present. Our sustainable investment strategies combine this bottom-up quantitative and qualitative ESG analysis into the investment due diligence process. Each pillar within ESG allows investors to better understand a company, with the aim of generating better returns.

The ‘E’ in ESG: why environmental protection matters

International efforts to reduce greenhouse gas emissions are set to intensify this decade as nations significantly step up their climate commitments.To meet the Paris Agreement objectives of 2015, by limiting global warming to below 2°C, accelerated action is likely later this year when nations meet at COP26 to set new five-year targets to tackle the climate crisis.This will bring increasing environmental regulation, higher carbon costs, greater transparency and greater customer scrutiny.

Companies who aren’t carbon efficient may face large risks to future cash flow – and future dividends. Higher carbon pricing will increase both the cost of operations and goods – directly impacting profitability if companies can’t pass those costs on.

Last year, Unilever – one of the world’s largest consumer goods groups – announced that it was putting carbon footprint labels on all its products¹. As other businesses follow suit, it’s likely people will become far more conscious of the carbon emissions from the products they buy.

It’s therefore prudent to consider these factors when working out the future revenue of a business.To do this, metrics such as ‘gross cash flow per tonne of CO₂ or equivalent greenhouse gases’ or, ‘scope one and two emissions per US$1m of fixed tangible assets’ can give insights into the resource efficiency of a company.

Carefully assessing a company’s dependence on factories and the remaining expected life of those assets, can help us to understand how willing an organisation might be to upgrade their ESG credentials. ‘Fixed-charge coverage ratios’, ‘margin volatility’ and a company’s available funds can also help us make sense of whether they can afford to transition.

Working out the influence and power of a company in its supply chain is also useful. For instance, a company such as Apple is in a better position to drive change than one of its smaller suppliers. Common accounting metrics such as ‘gross margin’ and ‘accounts payable days’ – the length of time it takes to clear all outstanding supplier and vendor payments – can help us to gather this information.

Analysing a company’s capitalised research and development to its gross investments as well as price-to-book ratios – a company's market value relative to its book value – can help determine where value is building in a supply chain. Knowing where a company is seeking to add brand value and adopting a policy of differentiation to stand out from its competitors is also useful. The more protective a brand is of its reputation, the more likely it is to drive constructive change in its supply chains.

The ‘S’ in ESG: how a solid social strategy makes more than financial sense

Since 1975, the share of intangible assets to the total market value of the S&P 500 has risen from 17% to an astonishing 90% today². Intangible assets, which aren’t physical in nature, include brand recognition, intellectual property, acquired goodwill, royalties and licensing, data and relationships.

For instance, in the technology space, one of Google’s most valuable intangible assets is its search algorithm, and for Facebook it’s the stores of data it has on its customers. While in pharmaceuticals, Reckitt Benckiser’s Nurofen brand and the patents on Johnson & Johnson’s immuno-oncology therapies are also both highly valuable assets. These intangible assets are products of human intelligence and creativity. Therefore, a workplace that can attract and retain great minds is of great value.

Our sustainable strategies look to only invest in the highest quality, knowledge-based businesses from across the globe. It’s therefore paramount we know how companies manage their workforce.

Can a company retain and develop talent? You can build up a picture by viewing metrics such as employee turnover, salaries, employee share ownership and training hours. How does it treat its female employees? Gender pay gap information, maternity and paternity pay can give plenty of insight. Perhaps the most important aspect, yet hardest to quantify, is the strength of a corporate culture, which underpins the small day-to-day decisions driving the larger outcomes of a company.

We only have to look at the current situation of staff safety in the pandemic to understand the impact of such factors. Companies with poor health and safety policies have had to close due to COVID-19 outbreaks – such as the food processing firms frequently mentioned in the press.

Those that have acted quickly and decisively have stayed operational and even thrived. Amazon, while under much media scrutiny early in the pandemic, invested into several initiatives to keep their workforce safe – including its own in-house COVID-19 testing which has reduced the amount of absences. Not only has Amazon remained operational throughout the pandemic, it’s also added over 400,000 staff to its workforce³ and now generates more than US$1bn of revenue a day⁴.

The ‘G’ in ESG: a focus on governance and the rest will follow

Powerful environmental and social policies can drive operational quality, reduce risks to future cash flow, attract the best talent, and encourage firms to operate sustainably within our planetary confines. However, none of this can happen without effective governance.

You can learn a lot from the compensation structure of a company’s leadership when looking to understand its priorities around ESG. An analysis of leadership structure can also highlight a company’s true motives behind driving ESG quality. For example, if the head of sustainability reports directly into the C-suite, it indicates a more serious commitment than if they’re positioned further down the organisation.

Bottom-up ESG research is a crucial part of the investment due diligence we carry out on all of the companies we look at within our sustainable strategy. This extra information allows us to make better investment decisions. In a world rife with the dangers of climate change and social injustice; where geographical boundaries have fallen away to include a global, remotely-working workforce, a focus on ESG quality has never been more crucial to both companies and investors.

All of the companies referenced in this article were companies held by our Sustainable Total Return Strategy as of 31 December 2020. They may or may not still form part of our portfolios. Reference to specific companies is not an opinion as to their present or future value and should not be considered investment advice or a personal recommendation. They’re included in this article to demonstrate the positive impact companies can have.

Related articles

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This communication:

• Has been prepared by Barclays Private Bank and is provided for information purposes only
• Is not research nor a product of the Barclays Research department. Any views expressed in this communication may differ from those of the Barclays Research department
• All opinions and estimates are given as of the date of this communication and are subject to change. Barclays Private Bank is not obliged to inform recipients of this communication of any change to such opinions or estimates
• Is general in nature and does not take into account any specific investment objectives, financial situation or particular needs of any particular person
• Does not constitute an offer, an invitation or a recommendation to enter into any product or service and does not constitute investment advice, solicitation to buy or sell securities and/or a personal recommendation.  Any entry into any product or service requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding documents
• Is confidential and is for the benefit of the recipient. No part of it may be reproduced, distributed or transmitted without the prior written permission of Barclays Private Bank
• Has not been reviewed or approved by any regulatory authority.

Any past or simulated past performance including back-testing, modelling or scenario analysis, or future projections contained in this communication is no indication as to future performance. No representation is made as to the accuracy of the assumptions made in this communication, or completeness of, any modelling, scenario analysis or back-testing. The value of any investment may also fluctuate as a result of market changes.

Barclays is a full service bank.  In the normal course of offering products and services, Barclays may act in several capacities and simultaneously, giving rise to potential conflicts of interest which may impact the performance of the products.

Where information in this communication has been obtained from third party sources, we believe those sources to be reliable but we do not guarantee the information’s accuracy and you should note that it may be incomplete or condensed.

Neither Barclays nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation. Law or regulation in certain countries may restrict the manner of distribution of this communication and the availability of the products and services, and persons who come into possession of this publication are required to inform themselves of and observe such restrictions.

You have sole responsibility for the management of your tax and legal affairs including making any applicable filings and payments and complying with any applicable laws and regulations. We have not and will not provide you with tax or legal advice and recommend that you obtain independent tax and legal advice tailored to your individual circumstances.

THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.