We have arrived at a pivot point. The balance of power is shifting from those that ‘produce’ to those that ‘consume’ tech - companies whose business models are operationally geared to productivity gains from software, collaborative robots – or ‘cobots’ – and AI.
But in a world where environmental, social and governance (ESG) investing is of ever increasing importance, investors don’t necessarily feel able to reward the world’s largest technology companies.
Within the Stonehage Fleming Global Sustainable Investment Portfolios, FAANGs stocks - namely Facebook, Apple, Amazon, Netflix and Google - that have driven the market upwards in recent years, are notable by their absence. This is mainly due to their low governance scores, but also, in the case of Amazon, thanks to environmental concerns.
The asset management industry was very much in ESG ‘hype mode’ in 2019 but flows, in fact, have been muted with $17.67bn into socially responsible funds in the US in 2019 according to the Wall Street Journal and around £30bn in Europe. Scarcity of decent funds and short track records have curbed investors’ progress. Once funds achieve three-year performance records, though, many investors will have the proof they need to galvanise this philosophical evolution into applied investment management.
We consider ESG to be an additional source of alpha for several reasons. At its most simplistic, it is an additional layer of risk management, for both equity and fixed income investors. Analysis of five-year credit default swap (CDS) spreads and ESG scores from 59 countries during 2009-2018 found that countries with the lowest ESG scores have, on average, the widest spreads and countries with the highest ESG scores have the tightest (Source: Beyond Ratings and Hermes Investment Management).
Furthermore, according to MSCI, companies with higher ESG scores boast a lower risk of incidents of fraud, embezzlement, litigation or supply chain issues. This in turn leads to lower drawdowns and better risk adjusted returns.
This is where two of the strongest market trends collide: the rise of ESG and the potential fall of big tech. Greater regulatory scrutiny has arrived for these non-capital intensive businesses – those that don’t require large upfront capital investments in machinery, plants and equipment to produce high volumes of goods or services. It is time for them to reform some of their governance practises. If they proceed positively, ESG investors and the market at large will reward them.
Younger technology businesses with higher cash burn rates can also take a leaf out of ESG investors’ playbooks. By focusing on the “G” they can make enhancements at a relatively low cost, improving transparency, accountability and ethics rather than reducing their carbon footprint (E) or tackling a lack of diversity (S), which can both require high budgets.
From big tech to newer fledgling businesses, if companies can embrace ESG practises, like the consumer and healthcare sectors, technology could enjoy a considerable ESG based re-rating.
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