Is sustainable investing synonymous with growth investing?

Morningstar’s head of manager selection Ruli Viljoen points out it is wrong to assume all sustainable funds invest in growth shares, picking out two value options in our ACE 40.  

This article is written by Ruli Viljoen, head of manager selection at Morningstar.

It is fair to say that the impact of Covid-19 will long live in our memories and will undoubtedly be the subject matter of many future studies and reports. From an investment point of view, it has certainly accelerated the push for a more sustainable and responsible investment approach, with the importance of social and environmental issues coming to the fore.

Markets sold-off aggressively in the first quarter of 2020 and in general funds with a sustainable remit, in relative terms fared better, resulting in many commentators quickly claiming the merits of a sustainable investment approach and its ability to outperform in periods of market weakness.

Digging beneath the surface, however, also revealed that on balance funds with a sustainable remit also hold a strong correlation to growth and often quality too. These factors too did well in the first three months of 2020, so perhaps the outperformance of funds with a sustainable remit had more to do with their quality growth style bias than their sustainable characteristics?

We have seen further evidence of the strong link between these factors in the performance of markets year-to-date, in which there’s been strong outperformance of ‘value’ funds and underperformance of ‘growth’.

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In their 2021 Stewardship Report, the Redwheel Equity Income team argue that value investors have ceded ground on environmental, social and governance (ESG) to ‘growth’ and ‘quality’ investor voices and that this needs to change. In their opinion, value investors should be playing a leading activist role in promoting sustainable behaviour among corporates.

Value portfolios often have relatively greater exposure to negative externalities such as carbon emissions and it falls on them as value investors to force change and have an impact. They highlight this is particularly crucial in the next decade when considerable action needs to be taken if we have any chance of meeting the aims of the Paris Agreement.

If we consider the energy sector as an example, while we may long for the day when society can completely switch from fossil fuels and rely purely on wind, solar and green hydrogen, realistically, this may be decades away, if ever wholly possible. In the meantime, energy companies must continue to meet our energy needs and they will do so, particularly the European majors, while at the same time moving to clean energy as they attempt to meet the goals of the Paris Agreement.

The transition requires massive investment from the sector in the proven areas of wind and solar, and the majors are committing further vast sums for development areas, such as green hydrogen and carbon capture. The Redwheel Equity Income team argue that starving well-run companies like BP of capital, when they are trying to be more responsible, is not the answer.

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This does not in any way suggest that these companies can continue polluting in the interim but does suggest that shareholders and those entrusted to represent shareholders (i.e. fund managers) have a role to play in as far as ensuring that company managements remain on track with their plans and to encourage them to go further and faster where possible.

From a fund selection point of view, it is important that investors consider multiple factors when selecting funds for their portfolios and be aware of both the intended and unintended consequences of their decisions. So while it is true that a strong correlation has traditionally existed between quality growth investing and sustainable investing, this does not necessarily have to be the case. We would argue that value investors have as an important a role to play and can arguably be even more impactful as the marginal rate of change is likely to be greater.

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Looking at interactive investor’s ACE 40 list, two funds that stand out as having more of a value style bias are BMO Responsible UK Income and Janus Henderson UK Responsible Income. While the income remit of both these funds lends itself to having a value style bias, this is by no means a necessary criterion for funds with a value style bias. Moreover, while both funds have lost value year-to-date they have significantly outperformed funds with a growth style bias and from a sustainability perspective are competitive within their peer group with strong sustainability characteristics too.

The Morningstar Sustainability Rating is a measure of how well the portfolio holdings are managing their ESG Risk relative to the portfolio’s peers and is expressed as a maximum globe rating of five. The BMO fund scores four globes, while Janus Henderson scores a maximum of five globes. Relative to peers both funds have below average carbon risk and fossil fuel involvement scores too.