European Equities

ESG - a fundamental consideration

It is now a daily occurrence to see an article in the financial press, praising the merits of environmental, social and governance (ESG)
June 2018

Sacha El Khoury

Vice President, Portfolio Manager, European Equities

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Risk Disclaimer 

Past performance should not be seen as an indication of future performance. Stock market and currency movements mean the value of, and income from, investments in the strategy are not guaranteed. They can go down as well as up and you may not get back the amount you invest.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

It is now a daily occurrence to see an article in the financial press, praising the merits of environmental, social and governance (ESG), lauding its success as an investment strategy and proclaiming it to be the next big thing in the asset management world.

We would argue that, as bottom-up, long-term stock pickers, ESG factors are a de facto element of the research we conduct on stocks, and have for many years now been fully entrenched into the team’s process and philosophy.

 

ESG and sustainable investing has long been a fundamental part of what we do.

 

How does responsible investing fit into our philosophy of not overpaying for well-run quality businesses?

In seeking compounders of growing returns over the longer term, we are acutely focused on the sustainability of franchises and the competitive advantages, or moats, that protect them. ESG factors are an integral part of this as they represent:

 

Risk Disclaimer 

Past performance should not be seen as an indication of future performance. Stock market and currency movements mean the value of, and income from, investments in the strategy are not guaranteed. They can go down as well as up and you may not get back the amount you invest.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

 

 
 

A closer look at supply chain risks

 
The integrity of a supply chain (sustainable access to raw materials, relationships with suppliers/farmers, fair treatment of workers, etc.) is a big component of the moats that protect businesses such as specialty chemicals companies, for example Kerry Group. Understanding their procurement processes gives us confidence that they have sustainable access to raw materials, making them less prone to disruptions, and enhancing the quality and predictability of the operations. This is why making sure companies have a degree of ownership and visibility of the supply chain is a key competitive advantage.

 
A harmonious global marketplace
 

The fair treatment of all stakeholders is an important consideration. Companies should not be looking to make supernormal returns by the exploitation of the geographical location of their customer base. For instance, luxury goods companies had for a while taken advantage of moves in exchange rates and, under the pretext of operating in different regions, were charging emerging market consumers exorbitant premiums, thereby making supernormal profits in these regions. However, as consumers became more mobile and travelled more, they quickly realised that they were being exploited.

 
In a connected world, where travelling is easier and cheaper, this approach to dealing with customers is not sustainable. Companies that operated with non-harmonising practices, and therefore treated their customers unfairly, have subsequently been forced to bring prices down and have destroyed entire pockets of supernormal profits. This was a contributing factor to the woes of Italian luxury shoemaker Tod’s, which has seen its fortunes decline ever since the Chinese government cracked down on ‘gifting’ in 2013.

 
The relationship between a ‘brand’ and consumers is often a key element of competitive advantage (the ‘moat’ around a business). If a brand’s reputation is damaged in any way and the relationship between a company and its customers deteriorates it can have significant negative implications for a company’s prospects.

 
Likewise, regulation, can make or break entire industries. Whether it is about taxing gambling revenues and promoting responsible gaming, or cutting Co2 emissions, these have direct impacts on our investments, and they are, once again, direct considerations.

 
Coming back to Continental – Continental Group is one of the main beneficiaries of regulation on CO2 emissions, which has accelerated the electrification of cars. As a main supplier to original equipment manufacturers (OEMs), Continental has kept a finger on the pulse and as a result has actively invested in electric components and autonomous technology, including Advanced Driver Assistance Systems. We expect the company to derive a growing part of its revenues and profits from these return-enhancing activities and help Continental maintain its wide moat around the business.

 

Effective engagement leads to constructive conversations

 
As I look across the desks that separate us from our dedicated, 15-strong, ESG team, I recall numerous examples over the years where we have engaged directly with companies over remuneration issues, independent directors, incentivisation, and so on.

 
Our principal belief and starting point is to invest in quality companies, because we believe that in doing so, the risk of permanent loss of capital is minimised. We spend an awful lot of time examining anything that can jeopardise a company’s operations, or in other words, anything that can threaten its competitive advantage, and incorporating environment, social and governance factors is an integral part of our everevolving process.
 

 

 
ESG – hardwired into our research process
 

Source: BMO Global Asset Management 

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