Sustainable Smith? Terry doesn’t get it

Written by Rebecca Jones on 2nd Nov 2017

Celebrated fund manager Terry Smith is apparently planning to “shake up” the ethical and sustainable investment sector with a new fund launch. While he will no doubt bring a flood of money and a lot of attention for this already popular and growing investment approach, his understanding of what is involved is a little unusual, if his comments in London’s Evening Standard on Wednesday are anything to go by.

Smith, formerly one of the sectors biggest critics, has woken up to the rewards of responsible investing thanks to a fund he has been running on behalf of Comic Relief. According to the Standard, this fund has returned 24 per cent a year since he started it in 2014 by avoiding traditional “sin stocks” like arms, gambling, tobacco, oil and pornography.

Of course for those familiar with this sector, this will come as no surprise, with study after study – from MSCI, Morgan Stanley and Deutsche Bank among many, many others – showing that applying ethical and sustainable criteria to an investment portfolio has led to big gains for investors over past decades.

It seems somewhat of a surprise to Terry, however. According to him, by excluding sectors and companies that are doing harm to society and the environment, ethical investors usually buy a “load of junk.”

I wonder, then, how he explains the out-performance of one of the most popular ethical funds in the sector – Kames Ethical Cautious Managed – whose “junk” portfolio has returned 86 per cent over the past ten years – making it the seventh best performing fund out of 70 in its mainstream sector. The fund is also a top performer over five, three and one years – smashing the average every time.[1]

It’s a similar story across the ethical universe – of the funds labelled “ethical” in the UK market that have a five year track record, 12 out of 17 – or 71 per cent – have delivered sector beating returns since 2012, with the top fund – Premier Ethical – returning close to DOUBLE that of its average mainstream rivals at 112 per cent.[2] It’s an impressive performance for a load of junk.

Sustainable means it lasts

Even more concerning than Smith’s lack of a clue about the ethical sector, however, is his understanding of sustainable investing. Again, according to the Standard, Smith thinks that ethical fund managers focused on sustainability don’t pay enough attention to whether the company they invest in will actually stay the course. “There is no point in having a sustainable portfolio that isn’t going to to exist in ten years,” he said.

This is such a fundamental misunderstanding of even the dictionary definition of sustainability that I don’t know where to start. As for the core mission of sustainable investing, however, I’ll let George Latham, chief investment officer at SRI-focused firm WHEB Asset Management – who I spoke to back in 2015 for an article in Money Observer – explain: “We invest in companies providing solutions to sustainability challenges because we think they will deliver superior growth to the market over the long term. For us, the sustainability strategy is the means to an end, rather than an end in itself.”

The whole point of sustainable investment is to invest in companies that will sustain – i.e. last a long time – and which companies do that? Ones that are working with and for society, rather than against it, and ones that play by government rules, look after their staff, and don’t fiddle the books or bribe politicians.

Of course plenty of bad guys still exist – tobacco has been going gangbusters for a hundred years or so now while oil and gas remains firmly wedged in the financial and political establishment. (Ex CEO of Exxon Mobil and now US Secretary of State Rex Tillerson didn’t take home £30 million a year or get where he is by marching with Greenpeace).

Nonetheless various companies trying to cut environmental and human rights corners have paid the price – as have their shareholders – from Volkswagen to BP to Bell Pottinger to too many mining firms to name to just about every major bank since 2008. Even big tobacco took a hit from a still unprecedented $206 billion fine slapped on it in 1998 for misleading the world about the dangers of smoking.

Future proofing

Quite rightly, Smith thinks longevity is the name of the game – he says that the average company in his new fund will have been founded in 1931. That’s great – lots of ethical and sustainable fund managers agree. For example, the average company in the Liontrust Sustainable Future Global Growth fund was founded in 1951[3], while the largest holding in Kames Ethical Cautious Managed, Prudential[4], was founded in 1848.

Companies doing right by the world last too – from insurers like Prudential, to those producing life saving cancer drugs and those building vital public infrastructure. These are the ones many ethical and sustainable funds target – to the benefit of investors.

However, as I’m sure Smith would agree (or maybe not) – it is also the job of professional investors to spot and nurture the great companies of tomorrow – to recognise where solutions are needed and to plough money into the firms providing them, adding some future-proofing to portfolios.

This is what makes sustainable investment, frankly, the only real long-term option. As the world battles new challenges around climate change, pollution, food production, water supply, poverty-induced terrorism and cyber crime – it is only innovative companies directly addressing these issues that will thrive.

So good luck, Mr Smith, but open your mind a bit – your investors might benefit.

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[1] Source: FE Analytics

[2] Ibid

[3] Source: Liontrust

[4] Source: FE Analytics