Sustainable investing can be unconstrained rather than restrictive

The evolution of envi­ronmental, social and governance (ESG) measures over the past 30 years has enabled a broader opportunity to under­stand the long-term sustaina­bility of global companies. 

In particular, over the past five years, the harmonisation and reliability of available ESG data has improved to the extent that fund managers can now assess the alpha correlations between key sustainability factors in a diversified portfolio. This data has allowed the integrated assessment of key ESG factors and the identification of sus­tainable companies that have repeatedly outperformed global markets since 2012. 

Despite this, many investors still perceive the integration of ESG considerations as a restric­tion, which serves to exclude companies that do not meet specific non-financial criteria from a portfolio. Should this still be the case? 

It is a question that is at the heart of the investment phi­losophy followed by Abbie Llewellyn-Waters, who runs Jupiter's Global Sustainable Equity strategy. For her, the highest quality companies are those that have sustainable business models in economic, environmental and social terms. 

Rather than only using tra­ditional investment models, she enhances her analysis with sustainability measures to better assess the long-term intrinsic risk of a company, which in turn helps identify structurally sound global businesses. Importantly, in identifying companies with higher quality and sustainable, longer-term visions, Llewellyn-Waters looks to avoid businesses that only manage for short-term profit gain. 

She explains: "In the strategy overall, we firstly aim to identify well-capitalised businesses with strong or improving cash flow characteristics and resilient oper­ational efficiency. ESG metrics are used later to enhance this fundamental analysis and help us understand how a company is positioned on a forward basis.

"The rigorous research pro­cess takes into account finan­cial analysis, and enhances that analysis with a range of stra­tegic ESG considerations such as resource usage, workforce treatment, and cyber security to provide more insight into the quality of a company. 

"Importantly, we do not use sustainability as a tool to exclude stocks from the investment selection process or direct us to areas to invest. It is a completely unconstrained approach." 

Economic sustainability 

The economic sustainability of a company is paramount to its success: it is after all the key driver of long-term alpha. But by applying ESG tools to an investment process in an unconstrained way, sustainability need not be restrictive. 

Rather it should positively enhance the stock selection pro­cess to highlight the companies that are likely to be leading for the long term. Llewellyn-Waters explains: "There is a perception in the market that when invest­ing sustainably the fundamental starting point should be ‘What sustainability theme should we target?' [But] the more impor­tant focus for us is actually to identify companies with strong, robust and disciplined business models. Therefore, consistency of economic sustainability should underpin environmental and societal sustainability." 

She adds that when sustaina­ble metrics are applied to stock analysis in this way, it can often reveal things about the quality of the management team or the operational approach a business is taking which help build a deeper knowledge of the com­pany overall. 

This process enables the man­agement team to better assess risks and identify how they are transitioning to a sustainable world economy: "It is an oppor­tunity to look at a company's direction of travel from an innovation and sustainability perspective, as well as consider how the company operates on a broader basis. 

"We can understand what its impact on the environment or society is, and how they are man­aging that impact. Companies who are not thinking about these risks are unlikely to be the highest quality companies in the market, in our view." 

Sustainable metrics 

The advancing growth of ESG reporting means there are over 400 independent data points that can be used to analyse a company today. Yet using large combinations of these to analyse a stock can often distract investors from those core areas which are most mate­rial to the long-term sustaina­bility of a company. 

In particular, using a broad-brush approach of applying all available data to ‘score' com­panies run the risk of simply rewarding those that disclose information, and is something Jupiter's Global Sustainable Equity strategy actively avoids. Instead, Llewellyn-Waters argues it is more important to focus on those metrics that provide appli­cable insight into the challenges certain companies may face. 

"There are a handful of met­rics that are universal across all sectors, market caps and geogra­phies," the manager explains. 

"Those typically tend to be more socially-focused around the treatment of employees. But generically applying the same tools to all companies will not help in assessing the future tra­jectory of a company. 

Using ESG data points in an unconstrained way during the investment process is likely to help managers identify the firms set to be ‘transitional leaders' in their industry. Furthermore, broadening the investment anal­ysis to include all stakeholders in the world economy suggests this type of analysis is unlikely to be the preserve of sustaina­ble strategies for much longer, according to Llewellyn-Waters. 

Abbie Llewellyn-Waters is a global equities fund manager in Jupiter's Environment and Sustainability team

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