Whereas the former is additive and process driven, the latter centres on what is being invested into and outcomes. Lately, an uncomfortable duality has played out in the market: green need not always be good, and bad might still be necessary – whether we like it or not.
This quarter, SKAGEN reached an important milestone by aligning our equity funds with Article 8 of the Sustainable Finance Disclosure Regulation (SFDR). The key hurdle was not the ambition – but communication. How do we highlight our commitment to ESG without diluting our goal of delivering the best possible financial returns to clients?
The 'light green' classification of our funds serves to answer this – they promote social and environmental characteristics but do not have these as their end investment objective. SKAGEN applies binding and routine components that anchor sustainability considerations into investment decision-making; we are about sustainable asset management.
Best suited for active managers
Active fund managers with concentrated portfolios and long investment horizons like SKAGEN are best equipped to scrutinise their portfolio companies and effect positive change. Successfully integrating this ability into the investment process will largely determine our ultimate goal of maximising risk-adjusted returns while also pushing for social and economic progress. Here SFDR also helps by strengthening ESG integration and its disclosure to clients.
For this reason, we were unsurprised when Morningstar's four-month review of SFDR revealed that active strategies dominate both Article 8 and Article 9 products[1].
Pragmatic patience is a virtue in its own right
We fundamentally disagree with the notion that investing in virtuous companies guarantees higher returns. Less popular companies have a higher cost of capital and thereby higher expected returns to compensate for additional perceived risk, and vice versa. Just as employing constraints (divestment) cannot enhance absolute returns, aligning portfolios with virtues will not automatically translate into vertiginous financial rewards.
We believe in active fundamental company analysis. Yes, a company that invests in its workforce and respects the local community will inevitably attract better qualified employees than less scrupulous competitors and thereby generate superior long-term returns. Likewise, taking advantage of high commodity and energy prices and investing in mining and oil companies that some consider 'sinful' may be the best way to discharge your fiduciary duty of maximising risk-adjusted returns.
It is a choice; passively avoid "sin" stocks or proactively find the long-term winners regardless of which sector they belong to. Active stock-picking – guided by a firm belief in value – can lead you to invest in companies with ambitious plans to cut emissions and provide consumers with materially greener power, which most accept will still be needed for several years. That we enter the fourth quarter amid a European energy crisis only highlights the frictions of our transition.
A big step in the right direction
In conclusion, SFDR has come at the right time for investors bamboozled by the proliferation of ESG funds, many of which over-state their sustainability credentials. While confusion also surrounds the new regulation, the dust will settle in the coming months. The extraordinary pace at which we are moving presents challenges for all, but SKAGEN will continue to learn and fortify the integration of sustainability into our investment process. There are no short-cuts in ESG or equity investing – patience and hard work are the only way to deliver progress, both for the companies we invest in and our clients' returns.
[1] Source: Morningstar, SFDR: Four Months After Its Introduction, Article 8 and 9 Funds in Review, July 2021