Ollie This week, my column on income investing touched briefly on the issue
of ESG for income investors. So, here to talk to me about that in more detail is Morningstar
Investment Management's Global CIO, Dan Kemp. Dan, can you just tell me a little bit more
about what the basic challenges are when it comes to integrating ESG into income investing?
Hello, Ollie. Of course, I'd be delighted to do that. Well, I think the first thing to remember
when making an ESG investment is that it is an investment. And so, all the same rules apply as
they would with any conventional investment. But there are a few things that you need to
take into account. And one is that a typical ESG portfolio will hold different securities,
different companies, from a conventional portfolio. And what that means is,
you're drawing your income, your dividend income, from different companies. Now,
the challenge for ESG investors is that a lot of the dividends available in the U.K.
come from older style companies which don't screen as well from an ESG perspective. And so,
you're likely to get less income if you're an ESG investor because you've excluded
the companies that provide a lot of that income. So, that's on the equities, on the share side.
And then, also, the other part of the portfolio is normally invested in bonds and fixed income
where you're lending capital to companies or governments. And again, you have different
companies borrowing your capital in an ESG portfolio, potentially in different governments,
and that can make a difference to the yield that you receive as an investor. So, same rules,
just a few different things to infer. In terms of risk, does that mean that
ESG investors in this space should look at the topic of risk differently given who might or
might not be involved on the other end at the companies or governments, as you say?
It's not a different risk. You need to think about risk in exactly the same way investors should be
obsessed with risk, certainly ESG investors, no less than anyone else. But the risks themselves
are different. So, think about it the same way. But the risks are different. And that is that
you tend to have these different holdings. So, the concentration of your holdings will be different.
So, you have to think about concentration more carefully as an ESG investor than you would as
a conventional investor. That's particularly true when lending money to companies because
fewer companies included in the ESG universe, what normally happens is you have greater
concentration, and of course, that means that your portfolio is a little less robust
to all the things that could happen in the economy than a conventional portfolio would do.
Okay. So, I'm just going to play devil's advocate here for a moment. So, share buybacks, I think,
are on my mind, and they've been criticized by certain commentators because they supposedly
funnel money away from, say, the transition to net zero or perhaps communities or local
infrastructure that companies rely on. Does that argument mean that
companies that involve themselves in share buybacks would automatically fail the ESG
tests? Or is it a little bit less black and white? That's absolutely wrong. The companies who are
taking buybacks, or rather, provide returns to shareholders in that way are not disqualified
from an ESG perspective. Share buybacks are simply a different way of providing capital
to shareholders. It's a more tax efficient way typically to provide that capital, and also,
it provides more flexibility to the managers of companies. Because unlike the dividend,
which companies tend to commit to for years at a time and feel compelled to provide that dividend,
share buybacks tend to be more opportunistic. So, it's just a different way of providing capital.
Now, what you do with that capital when it's provided back to you is entirely up to you.
And indeed, with companies, whether they send capital back to you or keep it themselves for
reinvestment, then again, they should be judged on what they do with the capital,
not how they distribute it. Okay. I'm glad to have been proven
wrong there. Dan, as ever, a massive pleasure chatting. More information on this and more,
check out our income investing coverage for this week's special report week on Morningstar.co.uk.
Until next time, I've been Ollie Smith for Morningstar.