Ignore ESG factors at your peril

15/08/2018

Humans are prone to focus on the short term by nature. Fighting our tendencies and taking a longer view can be especially important when it comes to putting money to work for our futures.

Glossary

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Short-term thinking can manifest itself in many ways. It might be the pursuit of profit today with neglect for the consequences – financial and otherwise. The latter can all too easily be ignored, yet we do so at our peril.

We must be long-sighted if we are to realise our investment goals, like generating a reliable and rising income. I believe a focus on environmental, social and governance (ESG) factors must be part and parcel of any genuinely long-term approach to investing in companies.

No bad deed goes unpunished

The implications of poor governance, and of disregard for the environment or society, are likely to undermine a company’s performance in the end, perhaps irreparably.

While a company might get away with profiting at the expense of the environment or society over the short term, in the longer run it is likely to prompt damaging costs. For investors in that company’s shares or debt, that could spell permanent financial losses.

This should be little surprise. We can probably all think of environmental or governance failures that have led to fines from regulators worth billions of pounds and sent share prices tumbling.

Then there’s the reputational damage of ESG failures to consider. Bear in mind it has been estimated that £1.7 trillion of the total value of UK-listed companies is stored in their reputations. When so much of a company’s value resides in its brand, misdemeanours or scandals can significantly undermine the future returns it is able to deliver for shareholders.

This risk is arguably as acute as ever in the age of around-the-clock news and social media. Not only can corporate misdeeds that might have previously been confined to local newspapers now ‘go viral’ and reach millions of potential customers and investors around the world, but it can do so in hours, or even minutes.

The court of global public opinion has been shown to offer swift judgment in the digital era. As Benjamin Franklin reportedly said, long before the advent of CNN and Facebook – “it takes many good deeds to build a good reputation, and only one bad one to lose it.”

Looking for sustainable success

Any company, however terrific its products or services might be, therefore cannot enjoy sustainable success if it ignores ESG factors. As investors, we should be better able to pick those companies with more sustainable businesses if we interrogate their performance against, and approach towards, the environment, society and governance.

It can admittedly be hard for individual investors to conduct deep dives into the long-term sustainability of a prospective investment. This is where investment companies can add value. Indeed, there is an expanding range of investment products that attempt to integrate ESG factors with more traditional financial analysis.

There can of course be no guarantees when it comes to returns from investing. The value of investments goes up and down, meaning how much your investments are worth will fluctuate over time, and you may not get back the original amount you invested.

Within the investment community, there is growing recognition that short-term thinking can ultimately end up being costly. As well as not delivering the best outcomes for society and the environment, ignoring the all-round sustainability of a business can make it less likely that investors will achieve their ambitions.

John William Olsen manages the M&G Global Select Fund and the M&G Pan European Select Fund. The views expressed by the author should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of any investment, speak to your financial adviser.