Michael Blayney: Why it’s better to stay the course on sustainable strategies, even when energy prices are high

Pendal’s multi-asset team has been examining the performance of ESG-friendly companies over the longer term. Here’s what they found

• ESG-friendly companies more efficent, better valued over time
• Whole-of-portfolio management can hedge against short-term risk
• Find out about Pendal Sustainable Balanced Fund
• Browse all Pendal’s multi-asset funds

INVESTING in sustainable funds is intuitively attractive to more and more people.

But when oil and gas prices soar as they did last year — leading to underperformance among sustainable funds — it’s not easy to stay the course.

It’s the type of scenario that Pendal’s multi-asset team faces on a regular basis, for example when making investment decisions for Pendal Sustainable Balanced Fund.

What factors might persuade an experienced, long-term investor to stick with the plan?

Firstly, research from Pendal’s multi-asset team shows it’s worth sticking with sustainable investments in such scenarios, because better-rated ESG companies outperform over the longer term.

More on that below.

Secondly, during those times, an active multi-asset manager can take steps to guard against single-risk factors such as rising energy prices.

“Investors with ESG strategies needs to have a long measurement horizon and be prepared to accept that their investments will have a slightly different performance cycle to a traditional, unscreened strategy,” explains Michael Blayney, who heads up Pendal’s multi-asset team.

“Investors need to understand their tolerance to that.”

“When you have a strategy that involves exclusions of particular sectors of the market, your fund is going to run into headwinds at times.

“Last year, particularly in the first part of the year, there were soaring oil prices. If you had a strategy that excluded or underweighted oil companies, then you faced headwinds.

“One way we managed that was to buy renewables in Europe, which gave us exposure to European energy prices within our alternatives portfolio,” says Blayney.

“Identifying and positioning for these types of risk factors can help portfolios perform better in the long term, and provide investors with a smoother, more comfortable ride in the short term.”

What the research tells us for long-term ESG investing

Pendal’s multi-asset team has spent a considerable amount of time looking at the long-term benefits of ESG investing.

Analyst Rita Bodrina recently examined MSCI ESG data going back to 2000, measuring the performance of companies that rate well on ESG metrics, companies that rate poorly and those with a relatively neutral rating.

One finding was that better ESG governance practices result in more efficient use of company assets.

Using sales on total assets as a proxy for efficiency, Bodrina found that companies in the top 20 per cent of ESG-rated stocks were more efficient that those in the middle segment of ESG ratings.

And they were sharply better than the bottom 20 per cent of ESG-rated companies. 

The study also tested an assumption that a stronger ESG profile would result in more favourable valuations and a lower cost of capital.

The thesis was that ESG-friendly companies may be less exposed to risks and thus a safer investment.

Bodrina found that ESG companies were better valued by the market through time.

Most importantly the study also demonstrates that, based on cumulative returns over 22 years, low-rated ESG companies underperform. This occured on both a stock-specific basis, and by industry segments. 

Better future outcomes

These effects could grow in the future, the team believes.

“This is due to a mixture of the regulatory backdrop globally, consumer and investor preferences, and a clear nexus between value creation and the fair treatment of all stakeholders,” Bodrina says.

Blayney says the bottom line is that more highly rated ESG companies do outperform — though historically this has been due to the underperformance of poorly rated ESG companies.

“It’s an interesting nuance that most of the return benefit comes from avoiding the bad stuff,” he says.

“Lower-rated ESG companies have also been more prone to downside risk, which supports the contention that a portfolio that tilts away from poor ESG companies should be expected to generate better risk/return characteristics through the cycle.

“Paying attention to ESG factors alongside traditional financial factors leads to better returns and better management of risk.

“Investors certainly don’t have to give up returns if they choose a sustainable strategy.”

About Pendal’s multi-asset capabilities

Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.

These include Australian and international shares, property securities, fixed interest, cash investments and alternatives.

In March 2024, Perpetual Group brought together the Pendal and Perpetual multi-asset teams under the leadership of Michael O’Dea.

The newly expanded nine-strong team will manage more than $6 billion in AUM and create a platform with the scale and resources to deliver leading multi-asset solutions for clients.  

Michael is a highly experienced investor with more than 23 years industry experience, including almost a decade leading the team at Perpetual.

Find out more about Pendal’s multi asset funds

Contact a Pendal account manager here