The past year has prompted reflection among ESG investors, as various challenges including conflict in Europe, supply chain disruptions and the cost-of-living crisis have renewed scrutiny of sustainable investments. While some of the debate surrounding ESG investing is helpful, much of it is misguided and focused on short-term factors, which can obscure longer-term investor expectations. However, it is important to maintain a long-term perspective.
Why focus on ESG factors?
ESG factors are simply non-financial information that can be financially material either today or in the future. Careful consideration of this information can improve an investor’s understanding of the risks and opportunities facing a company, which ultimately affect its performance.
Environmental outcomes such as greenhouse gas emissions are relatively easy to measure, but other factors like social value creation are more intangible. Regardless, investors need to understand the materiality of these factors to make better decisions that foster sustainable economic growth.
Increasing awareness of sustainability issues among investors and developments in ESG-related standards and disclosures have driven a paradigm shift in investment frameworks, where fundamental security and ESG analysis now go hand in hand. Companies are now compelled to consider ESG issues and all stakeholders in their decision-making. Investment managers are increasingly influencing company behaviour through their investment decisions and corporate engagement. This shift is not something that is greatly affected by short-term economic or industry cycles.
In fact, despite all the recent market challenges, the vast majority of Fidelity analysts report that their companies are placing the same or greater emphasis on ESG issues as they were a year ago.
The major economic disruptions of the last year will eventually settle – there are encouraging signs that energy prices have peaked, supply chains are normalising and inflation is slowing – providing the opportunity for a clarification of investors’ sustainable investing expectations.
A long-term, engaged and forward-looking approach
Long-term ESG factors can transform into short-term issues influencing market values. The recent downturn of Credit Suisse, plagued by governance challenges for multiple years, epitomises a series of prominent cases, such as the Boeing 737 accidents and the Brumadinho dam disaster affecting Vale. Nevertheless, consideration of ESG factors requires a long-term perspective, irrespective of the investment timeframe.
Many of the world’s sustainability challenges are long-term in nature and it can take time for market valuations to reflect a company’s contribution to a fairer, more environmentally sustainable world. In particular, the policies of COP and efforts to standardise a carbon price will impact on large emitting companies over decades. By prioritising companies and funds committed to credible sustainable practices, investors can benefit from related revaluations over time.
Much of the potential for improvement lays in the hands of investors. By engaging with companies on ESG issues, investors can use their influence to improve sustainable practices. A proactive approach recognises that many companies with unsustainable practices still play an important economic role in terms of goods and services, revenue and job creation, and require affordable capital to become more sustainable.
Blindly excluding companies based on ESG factors to create a “green” portfolio passes up on this opportunity to drive change and can also be a poor investment strategy. Divesting may reduce exposure to controversies but misses out on the benefit when companies improve their sustainability. Understanding company direction helps investors position for future value creation.
More broadly, investors that prioritise strategies and funds based on forward-looking ESG ratings can gain a more complete picture of a company’s long-term potential, emerging ESG risks, and better capture opportunities.
Traditional ESG ratings typically focus on past and present performance, rely more on company disclosures and lack standardisation.
Fidelity’s Sustainable Research Enhanced Equity ETFs
This is where Fidelity’s proprietary ESG Ratings come in. They focus on forward-looking assessments of sustainability and use of company interactions and due diligence by fundamental analysts to identify and assess material ESG risks.
With around 170 equity analysts and 40 sustainable investing professionals (as at March 2023), Fidelity’s global research platform provides extensive coverage, access to senior management and in-depth corporate knowledge. This provides the unique insights necessary for determining ESG factors’ relevance to company operations, financials and prospects, and the foundation for engaging directly with key decision-makers.
Investors can access Fidelity’s forward-looking fundamental and ESG research in a transparent, cost-effective manner through the Fidelity Sustainable Research Enhanced Equity ETF range. These funds aim to deliver market exposure to global and regional equities, with enhanced sustainability and climate profiles.
They target a 1% gross annualised return above their benchmark indices over a full business cycle, while reducing relative carbon footprint by 50% between 2020-2030 and aiming for net zero by 2050. The funds utilise Fidelity research to tilt exposure towards companies with higher sustainability ratings and those with upward sustainability trajectories.
This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To read the full magazine, click here.
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