Jim Gott, Head of Asset Diligence
ESG? ……It’s not about ESG, it’s about change and risk.
Investopedia defines ESG as:
“A set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.”
This description suggests that ESG is only relevant to ‘socially conscious investors.’ Mount Street fundamentally disagrees with this, not due to our ethical stance, but due to our sensible risk management stance.
The world is changing, there are many mega-trends that are reshaping the way that we live and think and it doesn’t take a rocket scientist (though we would like to think that Elon would agree with us) to work out that many of these changes are reshaping what is classed as acceptable. Plastics are a case in point, they moved from being a largely ignored by-product of the modern age to socially unacceptable in the blink of an eye.
To set the scene for the Mount Street ESG risk thesis we will steal a couple of quotes from Howard Marks of Oaktree fame (talking about equities):
- In dealing with the future, we must think about two things: (a) what might happen and (b) the probability that it will happen.
- Valuation eventually comes into play and those who are holding the bag when it does have to face the music
Mount Street has no doubt that within the next five years the E, S, and G concepts will have far greater importance when considering investments. In part, this will be driven by climate change and in part by social conscience.
Why does this matter? And why does it matter now?
If we consider what might happen:
- ESG assessments will almost certainly become commonplace.
- ESG+ve assets will likely be more attractive to investors than ESG –ve assets.
- Legislative changes required to address climate change will increase the CAPEX required for poor energy rated assets.
- ESG+ve assets could attract more tenants and thus have better yield, whilst the poor tenant attractiveness of ESG –ve assets may cause yield to drop.
- Some borrowers may become un-financeable.
- Climate risk assessment modelling could render some areas un-financeable etc.
We believe that the risk of the above happening is high, indeed it is almost certain that a number, if not all, of those scenarios, will play out.
In the worst-case situation, the outcome could be that an asset becomes stranded, or financially unviable. Re-financing may also become problematic or even impossible.
Our questions to investors are:
- What do you think will happen in the next five years?
- Will climate change assessment be more common?
- Will ESG assessment be more common?
- What happens if the results are unfavourable?
The crux of the matter is, we don’t think ESG is about getting today’s scorecard, it is about managing tomorrow’s risks.