Brandes Investment Partners 3rd-Quarter Letter: Price, Value and ESG

Oct 2020

Expensive Purchasers and Good friends,

Taking into consideration environmental, social, and governance (ESG) troubles is definitely a subject du jour with document flows into committed strategies. At Brandes, as a basic supervisor, we have usually sought to look at all troubles that impact a firm’s valuation, which include ESG features. We did this prior to ESG grew to become a commonly recognized acronym and continue to do so now. The core of our investment decision tactic has not transformed as a result of ESG getting common. But that does not signify we really don’t acquire ESG troubles quite very seriously and continue to evolve to boost extra sustainable investment decision tactics.

The rising trend in ESG investing details to a need by several buyers to make a distinction with their investments— environmental considerations, enhanced social situations and better opportunities for anyone via diversity and inclusion. These dreams are laudable and demand asset managers dig deep and definitely have an understanding of the fundamental troubles that generate enterprise valuations. This is why Brandes believes that a basic investing tactic is the very best way to kind via ESG troubles. We think an exclusionary or “box-examining” tactic is much way too simplistic and diminishes the honest targets of the regular ESG aware trader.

As the world wide ESG “field” grows, evidenced by the staggering inflows of $seventy one billion in the 2nd quarter of 20201, there is an understandable rush to categorize, quantify, rank and measure portfolios on their ESG attributes. In considerably less than a decade, sustainable money went from remaining a non-existent Morningstar classification to one particular where flows in 2019 were being 4x the prior document for a calendar 12 months. And to day in 2020, ESG fund flows have previously nearly matched past year’s document.2 As is often the scenario, these rankings can be a blunt put into practice and belie the ESG analysis that an investment decision supervisor could possibly be executing in the background. As a result, there is a hazard that these rankings come to be extra of a marketing gimmick pushed by box checking—arguably the antithesis of what an ESG aware trader is seeking to achieve.

For example, Prof. Samuel Hartzmark of the University of Chicago, mentioned that Morningstar’s introduction of “sustainability scores” for extra than 20,000 mutual money in March of 2016 marked important discrepancies in subsequent flows. “The worst ten{46dd52bca0123ad67b2d1222819e83fd0a56e45ca5068239f05f0c514f1e20f9} of money were being rated one particular world (very low sustainability) although the very best ten{46dd52bca0123ad67b2d1222819e83fd0a56e45ca5068239f05f0c514f1e20f9} were being rated five globes (large sustainability),” Hartzmark wrote. “About the 11 months following the sustainability scores were being printed, we estimate in between twelve and 15 billion dollars in property left one particular world money and in between 24 and 32 billion dollars in property entered five world money as a result of their world rating.”3

Past a label to attract capital, we consider organizations who acquire ESG troubles very seriously will, in excess of time, have a larger likelihood of accomplishing improved than organizations who really don’t. If a company and its administration acquire, for example, governance very seriously, it would probable run a extra successful enterprise, deal with trader capital prudently, have a competent and numerous board and be a superior steward of the enterprise on behalf of its shareholders. All of this is quite positive, but may perhaps obscure the distinction in between a “superior enterprise” and a “superior investment decision.”

The progress of the ESG field and passive investing has contributed, in our view, to several ESG darlings remaining possibly overpriced. Bernstein described “…there is evidence that in Europe, where the most capital has so much flowed into ESG investing, there is previously a unfold of valuations in between organizations that rating really vs. people that rating inadequately on common ESG metrics.”four Right now, we see large cost discrepancies in organizations or industries that are [ESG] darlings vs. people in the [ESG] penalty box. Seeking at the hole in between people players—arguably, there ought to be a hole, but ought to it be as terrific as it is in some areas?

Investing in these ESG darlings may perhaps check out the box when it arrives to investing in “superior” ESG organizations. Even so, in our see, all investors—including people focused on ESG— ought to look at the cost remaining compensated and ought to attempt to keep away from overpaying for a enterprise. Several organizations that are really rated when it arrives to ESG are at the moment at or previously mentioned what we estimate as their complete value.

For example, the subsequent chart highlights the major ten securities in the MSCI ACWI ESG Leaders Index, one particular of the most commonly employed for replication by passive ESG ETFs. These organizations trade at a materially larger valuation amount than the wide MSCI ACWI Index.

Supply: MSCI, FactSet as of eight/31/2020

A investigate-intensive, basic investment decision tactic can aid navigate the intersection of ESG considerations and valuations. For example, with a concentrate on cost and value, we consider some of the very best investments, each from a return potential and ESG stewardship viewpoint, could be in lower-rated ESG organizations considering the fact that an improve in share cost could possibly be pushed by enhancements in its ESG tactics. And as an energetic supervisor who is engaging with organizations, that is accurately how we can incorporate value as opposed to basically shopping for the optimum ESG-rated organizations and mainly ignoring others. This company-unique concentrate together with dependable energetic possession permits us to really encourage the enterprise to boost its ESG efforts—helping to achieve the targets of the ESG aware trader although preserving the cost/value equation in sharp concentrate.

In spite of the amount of money of money that has flowed into money that contains the ESG moniker, we do not consider that ESG analysis ought to be considered a stand-on your own investment decision fashion, tactic, or asset course. Relatively, from the viewpoint of a long-phrase trader, it ought to be considered of as a basic part of owning and functioning a enterprise. We really encourage you to look at ESG from this viewpoint and also really encourage you to review our Responsible Financial investment Assertion to even further have an understanding of how we incorporate ESG troubles into our basic investment decision approach.

Thank you,
Brandes Financial investment Partners

1 Emily Chasan, Lengthy-Expression Buyers Now Keep Sway About ESG. Bloomberg.com, UBS, August 13, 2020
2 Jon Hale, Ph.D, CFA. Sustainable Resources Keep on to Rake in Belongings For the duration of the Second Quarter. Morningstar. July thirty, 2022 Memo to Oaktree Purchasers, Howard Marks (Trades, Portfolio), Oaktree Funds Administration, June twelve, 2019.
3 Hartzmark, Samuel M. and Sussman, Abigail B., Do Buyers Value Sustainability? A Natural Experiment Inspecting Position and Fund Flows (March 25, 2019). European Company Governance Institute (ECGI) – Finance Doing the job Paper No. 565/2018, Out there at SSRN: https://ssrn.com/summary=3016092 or http://dx.doi.org/ten.2139/ssrn.3016092
four Fraser-Jenkins, Inigo Sarah McCarthy, CFA Alla Harmsworth and Mark Diver. “Fund Administration Technique: The scenario for and versus ESG.” Bernstein. February 28, 2020.

This materials is intended for informational uses only. The details furnished ought to not be considered a suggestion to purchase or offer any unique safety. It ought to not be assumed that any safety transactions, holdings or sectors talked about were being or will be profitable, or that the investment decision suggestions or decisions we make in the future will be profitable or will equal the investment decision general performance talked about herein. Strategies talked about herein are topic to improve at any time by the investment decision supervisor in its discretion due to industry situations or opportunities. The Brandes investment decision tactic tends to result in portfolios that are materially diverse than their benchmarks with regard to attributes these types of as threat, volatility, diversification, and focus. Market situations may perhaps impact general performance. International and emerging markets investing is topic to certain pitfalls these types of as currency fluctuation and social and political improvements, distinctions in economic reporting expectations and considerably less stringent regulation of securities markets which may perhaps result in better share cost volatility.

The foregoing reflects the thoughts and viewpoints of Brandes Financial investment Partners® exclusively and is topic to improve devoid of see. Brandes Financial investment Partners ® is a registered trademark of Brandes Financial investment Partners, L.P. in the United States and Canada.

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