The traditional concepts of the investor and investing are being swept aside as lower investing costs, easier access to capital markets and a growing awareness of the power of shareholders are attracting a more diverse group of investors and fundamentally altering the landscape for investment products.
We see this most obviously in the rise of sustainable investing, but it is also evident in the popularity of meme-stocks and cryptocurrencies.
As investors evolve, so must those who serve them and so the question becomes: how do we best help these new investors reach their goals? This is especially relevant for those of us involved in ESG investing as the Venn diagram of ESG investors and new investors has a large area of overlap.
Present or future?
A key difference between traditional investors and new investors is that the latter are using their capital to create experiences in the present rather than focusing their investments for the future. Such experiences range from the excitement of owning a volatile asset with upward price momentum to the satisfaction of owning an asset with limited availability.
However, the most relevant to ESG investing is the experience of feeling that you are making a contribution to the fight against climate change or improving society.
If you have been working with investors for a while, you may scoff at this view as we know that this preference for the near term over the long term is not new. Behavioural scientists have long explored the phenomenon of ‘present bias’ or ‘temporal myopia’ and advisers are very familiar with the challenges of encouraging clients to save. What has changed is the fact that investment has typically been regarded as a way to combat present bias rather than express it.
As investors increasingly look beyond traditional risk and return metrics as the key measure to the attractiveness of investments, the discipline of traditional investment approaches can be lost. This is a particular challenge to ESG investors as the intermingling of a client’s values and their investment objectives is integral to this form of investing.
Rise of thematics
A good example of this challenge is provided by the emergence of thematic funds. Funds that contain equities relating to a specific theme rather than providing exposure to a specific part of the capital markets are not new but have become increasingly popular over the past few. From resource management to energy transition, it is easy to find thematic funds that are attractive to sustainability-oriented investors and is it unsurprising that the theme of energy transition has dominated the flows into thematic funds over the past couple of years.
While these products are naturally appealing to investors that wish to express their values through their investments, our duty as advisers and professional investors is to our clients’ future selves as well as their present selves and that the core role of an investment is to deliver attractive risk adjusted returns. We must therefore have a clear understanding of whether a thematic fund represents good investment rather than simply an attractive narrative.
Unlike traditional asset class products, thematic funds do not have recognised benchmarks with established track records. They are therefore less susceptible to traditional asset class analysis. We must, therefore, adopt a different approach while adhering to the timeless rules of investment.
Chief among these rules is the importance of valuation. We know that the price at which you buy an investment is a key determiner of the future returns. A clear assessment of the valuation of a thematic fund is therefore vital if we are to determine whether the fund has utility in the long-term as well as the present.
For example, we use two valuation approaches as the companies held in thematic funds are typically growth oriented and so it is important to understand the value of that growth potential (using the work of Frank Donaldson Brown) as well as the current value of the business (using insights from Bruce Greenwald).
We currently track 24 funds that are both aligned to the concerns of ESG investors and widely available on platforms. Using this approach we can assess thematic portfolios in absolute terms and in comparison to other products, either those with the same theme or traditional asset class groupings.
While many thematic funds remain richly priced when compared with more traditional asset class groupings, the decline in equity prices over the last year has made many funds more compelling and some (such as those focused on healthcare) appear to be attractively priced when compared with other investment options.
Consequently, investors are increasingly able to experience the pleasure of expressing their values through their portfolio while accessing investments that are well positioned to support their future. This may appear to represent a small change, but it is an important step in the evolution of the investor.