Facing up to ethicalinvestment

There are many definitions of

what exactly ethical investing is; in

essence it is the use of non-financial

preferences which individuals and

investment professionals use to

guide their investment selection. One

investor’s perception of an ‘ethical’

investment may be very different from

another and so the use of ‘negative

screening’ to exclude unethical

companies (e.g. defence or tobacco

production) is increasingly being

seen as a crude methodology on its

own. In its place the use of ‘positive

screening’ and environment, social

and governance (ESG) factors is

being recognised as a way to highlight

investments that may have a better

chance of generating positive long

term risk adjusted returns and fulfilling

individual ethical criteria.

Thanks to real time information

today’s consumer is much

better informed and has become

highly engaged on how products

and services are sourced and

provided. Not only are ethical

preferences driving consumer

behaviour in the real economy

but also within financial markets.

According to Bloomberg data

assets under management being

run in Environmental, Social and

Governance (ESG) funds has grown

from US$292bn in 2013 to US$446bn

in 2017. Due to the nuance of

definition this may dramatically

under estimate total ESG assets but

the trend is undeniable.

This trend is set to continue thanks

to demographics; according to

a recent YouGov poll, millennial

savers are twice as likely as older

generations to want their pension to

be invested responsibly. According

to the research conducted last year,

13% of 18 to 34 year olds with a

pension think it is their responsibility

to ensure their money is invested

ethically compared with 6 per cent of

45 to 54 year-olds and 7 per cent of

over-55s.

Ethical investment returns

Ethical investing has its critics

and misconceptions with the

main fear focused on the process

leaving investors with a restricted

investment universe and the

potential opportunity cost on

investment returns. However there

is increasing academic evidence(i)

to counter this. Clark, Feiner &

Viehs argues there are strong and

increasing relationships between

ethical/sustainable business

practices and corporate economic

performance. This should not

come as a surprise and according

to Jonathan Yousafzai, Head of

Ethical Investing at Thesis Asset

Management “companies that are

forward-looking, innovative, focused

on the delivery of economic, social

CONTINUED ➤

Companies that are forward-looking, innovative, focused on the delivery

of economic, social and environment improvements should ultimately be

better stewards of shareholder capital.

(i) Clark, Feiner & Viehs - From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance, 2015

ThesisMarketCommentary

� August 2018 �1

CONTINUED

Thesis Market Commentary

and environment improvements should ultimately be

better stewards of shareholder capital”.

The chart (Figure 1) illustrates the relative performance

of the MSCI Social Index vs the S&P 500 as you can see

the social index has outperformed over the long term.

The power of ESG analysis

Back to the developed markets the recent events at the

US listed social media company Facebook throws up an

interesting example of a company which on the face of

it (no pun intended) should clear an ethical screening

process but may be disqualified if further ESG analysis

is carried out. Since the Cambridge Analytica scandal

in April 2018 the investment community has started to

question if the company’s current business model is truly

sustainable. The core earnings of Facebook are driven

by on-line advertising whereby through analysis of huge

amounts of customer data (freely given by Facebook

customers) Facebook helps advertisers more accurately

target advertising campaigns.

The Cambridge Analytica scandal throws into question

Facebook’s social contract with its customer and indeed

its social licence. The saying: “If you are not paying for

it, you’re not the customer; you’re the product being

sold.” Has made customers reassess their relationship

with the company.

As one can see from the chart (Figure 3) Facebook has

been a very strong performer relative to the overall

US market (S&P 500) since the company listed in May

2012 but as investor anxiety has increased so has the

company’s stock volatility.

CONTINUED ➤

Figure�1: Historic Outperformance of the MSCI Social Index vs S&P 500 2008 - 2018 (10 years)

Figure�2: Historic Outperformance of Emerging Market ESG Leaders Index 2008 - 2018 (10 years)

Figure�3:� Facebook Share Price v the S&P 500 2013 - 2018 (5 years)

Such outperformance of ethical strategies is not limited to

developed markets it is a global phenomenon, indeed the

outperformance of the MSCI Emerging market benchmark

vs MSCI Emerging market ESG benchmark is arguably more

pronounced. Please see this illustrated in the chart (Figure 2).

� August 2018 �2

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n MSCI Social Index

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SOURCE: MSCI

SOURCE: MSCI

SOURCE: MSCI

n MSCI Emerging Net Total Return USD Index

n MSCI EM ESG Leaders Net Total Return Index

n FB US Equity – Last Price

n SPX Index – Last Price

CONTINUED

Thesis Market Commentary

Bill Gates during deposition in August 1998

(Photo: Stills from videotape of Bill Gates'

deposition at 1998 United States v. Microsoft trial)

Mark Zuckerberg testifies before congress on 10 April 2018

(Photo: AP)

Microsoft’s experience

highlights the power that

ESG analysis can have on

identifying business that

fail to champion sustainable

business practices

development company, GitHub Inc.

Historically Microsoft aggressively

defended its software licenses and

saw open source developers as a

threat, via the GitHub acquisition

Satya Nadella stated that it

would “Strengthen [Microsoft’s]

commitment to developer freedom,

openness and innovation”. A real

departure from the company’s DNA

under the prior leadership of Bill

Gates and Steve Ballmer (CEO from

January 2000 to February 2014).

It is too early to tell if the recent

missteps at Facebook will lead to

longer term underperformance but

Microsoft’s experience highlights

the power that ESG analysis can

have on identifying business that fail

to champion sustainable business

practices and thus may face

headwinds to its corporate economic

performance going forward.

At Thesis our Ethical Investment

specialists, headed by Jonathan

Yousafzai, have over 60 years of

experience in researching, analysing

and monitoring ethical portfolios

on behalf of our clients. Our ethical

service is run on a bespoke basis

allowing each client to customise

their portfolios as much (or as little)

as they desire depending on the

strength of one’s personal values.

We believe ethical investing does not

have to be mutually exclusive with

long term investment returns but

consideration regarding performance

vs non ethical benchmarks is

necessary.

This is not the first time

a technology company

has experienced concerns

around its social impact and

governance that coincided with

the underperformance of the

company’s stock price. In 1998

the US Department of Justice

accused Microsoft Inc. of violating

the Sherman Act on the grounds

that they held a monopoly and

were engaging in anti-competitive

practices to force customers to

use its operating system and web

browser on Intel based personal

computers.

During Mark Zuckerberg’s recent

testimony in front of Congress

Utah Republican Sen. Orrin Hatch,

pointed out the historic similarity:

“Well, in my opinion…this is the

most intense public scrutiny I’ve

seen for a tech-related hearing

since the Microsoft hearing that

— that I chaired back in the late

1990s.”

The importance of a company’s

culture on its market value can

be seen by the performance of

Microsoft since Satya Nadella

became CEO in 2014 when he

started to transform the company

culture.

Microsoft’s transformation is

exemplified by its recent acquisition

of the open source software

TimHarman

InvestmentManager, Guildford Office Email: tim.harman@thesisam.com

� August 2018 �3

Thesis Market Commentary

Indices Value�as�at�31/07/2018

%�Change��on�month

%�Change�2018�year��

to�date

%�Change�on�12�months

FTSE100Share 7748.76 1.46% 0.79% 5.11%

FTSEAllShare 4253.31 1.22% 0.75% 5.12%

S&P500 2816.29 3.60% 5.34% 14.01%

Dow Jones 25415.19 4.71% 2.82% 16.10%

EuroStoxx50EUR 3525.49 3.83% 0.61% 2.21%

Nikkei225 22553.72 1.12% -0.93% 13.19%

MSCIEmergingMarkets 1087.46 1.68% -6.13% 1.99%

UKTreasury4.25%2027 125.60 -0.59% -2.33% -2.85%

Sterling/US$ 1.31 -0.53% -2.96% -0.50%

Sterling/Euro 1.12 -0.66% -0.23% 0.50%

SOURCE: BLOOMBERG

Julywasamoreencouraging

month,withmanyequityindices

aroundtheworldrecording

modestgainsandbouncing

backfromlossesinJune.

Chinesemarketshowever

continuedtounderperform,

weigheddownbythethreatof

tradetariffsaswellasweaker

economicdata.

UK

Whilst Brexit remains the elephant

in the room, Sterling continues

to act as a shock absorber for

the equity market as renewed

weakness fed through into earning

upgrades, particularly for the large-

cap overseas earners. There was

however a hint of change in market

leadership as the commodity sectors

were weak, particularly mining,

and the sectors that fit into the

defensive basket, such as Tobacco

and Consumer Staples performed

better. British American Tobacco and

Reckitt Benckiser in particular, had

positive quarterly results, further

accentuating this effect.

US

President Trump is never out of the

headlines and July was no different,

with a trip to Europe to visit its

political leaders, irregular updates

on his tariff strategy and direct

criticism of his own central bank’s

monetary tightening and its role

in the strengthening of the Dollar.

Whilst such events can be nervy, we

continue to focus our attention on

the strong company results, ongoing

strength in employment and resilient

economic activity. The US economy

actually just recorded its strongest

pace of growth since 2014 at 4.1%

and a number of key economic

indicators remain encouraging. The

ISM manufacturing index increased

from 58.7 to 60.2 and the three-

month trend in job additions remains

above 200,000, suggesting a robust

hiring backdrop.

Eurozone

Most European economies have

experienced a slowdown since last

year, but growth is still strong by

historic standards. A combination

of high business and consumer

confidence, falling unemployment,

gently rising wage growth and

supportive financing conditions

should see domestic spending fare

well on the whole. In fact demand

for consumer credit increased at

its fastest pace in nearly two years,

and points to annual household

consumption growth rising from

1.6% in the first quarter of 2018

to around 2.5%. Mario Draghi,

President of the European Central

Bank reiterated his positive view,

while keeping interest rates and

accompanying message the

same as last month, which means

quantitative easing will wind down

into the end of the year and interest

rates will likely rise but not until the

summer of 2019 at the earliest.

CONTINUED ➤

Summary

Equitymarketsweregenerallyhigher

RenewedSterlingweakness

RobustsecondquartereconomicgrowthfromtheUS

BankofJapan’smonetarypolicymeeting

Governmentbondyieldswerehigher

� August 2018 �4

NEWS&VIEWSCONTINUED

Thesis Market Commentary

Japan

The Bank of Japan’s (BoJ) policy

committee meeting generated a few

days of intense speculation and the

Yen was in focus following leaks the

BoJ may tweak its current bond and

equity buying program. Members of

the BoJ expressed concerns that the

current program was unsustainable.

At the 31 July meeting, the BoJ

announced it will allow greater

flexibility in its bond buying program

and allocate more of its ETF buying

to the Topix from the Nikkei. The

changes however denied previous

speculation that the bank would

remove its present lid on 10-year

yields, a move that would have most

likely steepened the yield curve,

helping bank profits and therefore

improving the flow of credit into the

economy.

Emerging Markets

Chinese equity markets were under

pressure as trade relations between

the US and China deteriorated

further which is raising concerns

about slower future growth rates.

The Chinese response has been

both rapid and significant, easing

monetary policy and providing a

fiscal boost to offset the potential

future risk to growth. We remain

cautious as we head towards the

US mid-term elections in November

as it is unclear how potential trade

policies will play into the political

rhetoric. Other emerging markets

equities staged a rebound in July,

led by Latin America as Brazil and

Mexico posted strong gains on easing

domestic political concerns.

Fixed Income

Government Bonds yields were

higher (prices lower) over July,

having mostly moved sideways

in June. US, Euro and Sterling

corporate bond markets all posted

positive returns however and amid an

improvement in sentiment, high yield

outperformed investment grade.

Commodities

Crude oil was volatile during

the month as President Trump

threatened his Iranian counterpart

via a Twitter message and OPEC

announced supply increases. Copper

prices fell sharply, particularly into

the end of the month, to hit year-to-

date lows after economic data from

China suggested slowing economic

growth and rhetoric around trade

wars continued. The copper price

is closely watched by market

participants because of its ability

to predict turning points in the

global economy, so the recent falls

are being monitored closely for any

further deterioration.

At the 31 July meeting,

the BoJ announced it will

allow greater flexibility in

its bond buying program

and allocate more of its ETF

buying to the Topix from

the Nikkei.

Important� Information This update is for information only and is not an invitation to engage in investment activity. Issued by Thesis Asset Management Limited, Exchange Building, St John’s Street, Chichester PO19 1UP. Authorised and regulated by the Financial Conduct Authority (registration number 114354). Investors should be aware that the value of their investments and the income from them can fall as well as rise and they may not receive back the full amount they invest. Past performance is not a guide to future performance. Investments denominated in foreign currencies are subject to fluctuations in exchange rates which can be favourable or unfavourable. TAM1808_11.

RyanPaterson

ResearchAnalyst Email:ryan.paterson@thesisam.com