Sustainable Investing: Don’t forget the humans

Morningstar identified 860 funds with a climate-related mandate in 2021 and estimates this number increased by more than a third in 20221 Financial regulators are calling for investors to increase their climate-risk disclosure and there is an increasing number of industry collaborations such as the Glasgow Financial Alliance for Net Zero. This increased attention to climate change by the financial community is both welcome, and understandable, given the frequency of record-breaking weather events and concerning levels of pollution and biodiversity loss we face.

Climate change is one of our greatest threats. At Stewart Investors we consider it a key investment risk, and an investment opportunity. However our definition of sustainability is broader than just climate change, and encompasses a wide range of environmental and human development considerations. Instead of viewing sustainability issues in isolation, we think of them as part of an interconnected and interdependent web of challenges.

Take income inequality as an example. It is usually linked to access to education, which is often linked to poverty, which can be linked to food insecurity, which is increasingly linked to climate change and biodiversity loss, which can link back to poverty and inequality, and so on. Efforts to improve human development will be limited if we don’t address climate change, and efforts to address climate change will be undermined, if we don’t improve human development.

Why? Let’s consider demographic change. In 2022, the eight billionth person was born2. The world’s population grew by one billion people over the last 12 years3, mostly in Asia. It is currently growing by more than 200,000 people each day4. As things stand, 70% of the world’s population live in countries running an ecological deficit while generating a below-world-average income5. If everyone is to live like the average Brit or American, we will need at least 3-5 planets worth of resources to sustain ourselves.6

The Global Footprint Network illustrates this point well, and maps countries according to their human development and ecological footprint. 

The Human Development Index (horizontal axis) measures a country’s life expectancy, education and income. The ecological footprint (vertical axis) measures the stock of natural resources it takes to sustain a country’s economy and population.

As countries improve their human development, they also tend to increase their ecological footprint. Wealthy people and countries have a disproportionately large ecological footprint and some studies suggest they are responsible for a growing proportion of total global emissions.7

So it is clear we need to change, and find ways to improve living standards while staying within environmental limits. This requires governmental action and broad societal change, but the private sector has a crucial role to play too. This is our investment hunting ground, where we search for publicly-listed companies that are helping societies move to the bottom right-hand section of the chart above.

How do we invest?

Our investment philosophy is to only invest in high-quality companies that we believe are contributing to a more sustainable future. We look for companies that are helping to reduce our ecological footprint, or advance human development, or ideally both. Some companies are reducing healthcare costs, or providing financial services to lower income communities in emerging markets. Others are providing technologies for electrification, waste reduction and industrial process efficiencies.

Many companies are doing wonderful things for society or the environment, but we only invest in those that meet our high quality criteria. Equally, there are many high-quality companies in our investable universe that we avoid because they are not contributing to a more sustainable future.

When we refer to quality, we don’t simply focus on high margins, profit growth and returns. We take a more nuanced and qualitative approach, and assess the quality of the people running the businesses, the quality of the franchises and the financials.  Among other things, we look for companies led by outstanding, long-term focused stewards, who look after all their stakeholders. We look for franchises that are resilient, competitive and have pricing power. And we look for companies with simple and conservative financials, with strong balance sheets, that avoid financial shenanigans.  

Similarly, for sustainability, we don’t rely on simple Environmental, Social and Governance (ESG) scores, or carbon footprints. We focus on the societal impact of the products and services being sold; on how company leaders behave; on the operational impacts of the company, and on how well placed a company is to benefit from sustainability tailwinds.  We pay just as much attention to human development as we do to environmental issues, because both are equally important for a more sustainable future.

We believe this rounded approach to sustainable investment helps us avoid and mitigate risks, identify opportunities that are different from our peers, and above all, deliver strong returns.