Raising the bar

A key part of our process is to consider the long-term themes that are driving economies and financial markets over the long term. These typically fall into two main categories, demographic change and technological development. This week we would like to consider one which straddles many of our other themes and goes beyond.

Over the past five years we have noticed the growing importance of issues which fall under the banner of ESG (environmental, social and governance). For quite obvious reasons, these issues must always form part of an investment process in order to avoid overpaying for businesses that are heading for inevitable disaster. At the current time ESG has become something much greater than in the past. An increasing number of clients, both individual but importantly the large pension funds and sovereign wealth funds, now have to some greater or lesser degree an ESG overlay. At the same time even funds with no explicit ESG mandate are, through the inevitability of it becoming a factor in their firm’s overall investment procedures, considering ESG on a day-to-day basis.

It is a truism that what you measure is what you manage. ESG is now something that is widely measured, by a range of organisations and these ‘scores’ are available. Fund managers by their nature will want to score highly on these measures. When looking at two otherwise comparable investments the higher ESG score will inevitably be preferred. Companies will also seek to improve their scores in order to attract further investment.

ESG & Market Performance

Stocks of sustainable companies tend to significantly outperform their less sustainable counterparts

Evolution of $1 invested in the stock market in value-weighted portfolios

Source: Forbes, https://www.forbes.com/sites/georgkell/2018/07/11/the-remarkable-rise-of-esg/#4b7fd0f41695

The chart above shows how on one measure positive ESG companies have outperformed. Whether this is driven by supply and demand or superior business performance is arguable.

It is inevitable that demand for investments in companies with high ESG scores will exceed demand for those with low ESG scores over and above that which is justified by these companies superior long-term prospects. This reduces positive ESG companies cost of capital and therefore, enhances their performance, driving positive change over time.

In contrast those polluting, harmful or poorly governed businesses will suffer a higher cost of capital than even that justified by their poor business models. This creates a headwind for performance over time for these companies and reduces their access to capital.

We see this as a similar shift as that towards to indexation over the past decade or so. More and more funds have moved to an indexed mandate for cost reasons over the past decade. This has driven demand for the largest stocks which appear in the most indices. This in turn has led to outperformance and a lower cost of capital for the largest most popular stocks at the expense of smaller companies.

As active managers we have always had a preference for well governed businesses with ‘future proof’ business models. The ESG trend makes it likely that such companies should be even more popular with investors than less ESG friendly businesses. That creates a trend that we as active managers can take advantage of to gain an edge. We would not seek to constrain our process but the bar to invest in bad businesses is clearly being raised over time and like-for-like we will continue to have a clear preference for positive impact businesses.


The value of stock market investments will fluctuate and investors may not get back the original amount invested.

Forecasts are not reliable indicators of future performance.

The performance information presented in this commentary relates to the past. Past performance is not a reliable indicator of future returns.

Important Information

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Source for information: Miton as at 13/11/2019 unless otherwise stated.

The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.

Miton has used all reasonable efforts to ensure the accuracy of the information contained in the communication, however some information and statistical data has been obtained from external sources. Whilst Miton believes these sources to be reliable, Miton cannot guarantee the reliability, completeness or accuracy of the content or provide a warrantee.

This financial promotion is issued by Miton, a trading name of Miton Asset Management Limited the Investment Manager of the Fund which is authorised and regulated by the Financial Conduct Authority and is registered in England No. 1949322 with its registered office at 6th Floor, Paternoster House, 65 St Paul’s Churchyard, London, EC4M 8AB.