• ESG is the acronym for “environmental, social and governance”. As more investors embrace “responsible investing”, the degree to which a company observes or fails to observe these non-financial standards in its operations, is increasingly being scrutinised and taken into consideration by the investment community in their investment decision making.

• We believe ESG investing is a mega trend in investing that can only get more prominent each day. The key driving force behind ESG investing is no longer confined to conscience and philanthropy, but has extended to practicality. It has gathered so much momentum in recent years that fund managers who ignore it may risk missing the boat, potentially resulting in underperformance of their portfolios, as the writing has been on the wall for a while.

• We believe ESG investing is increasingly becoming “mainstream”. A case in point is the rapidly rising number of signatories of the Principles for Responsible Investment (PRI), an initiative started in 2005 by an international network of investors and backed by the United Nations, to promote the incorporation of ESG issues into investment practices across asset classes. From a humble beginning of only 100 signatories representing US$6.5 trillion of assets under management in April 2006, the number has grown tremendously to 3,300 signatories representing US$103.4tril of assets under management as at March 2020.

• We hold the view that despite potentially reduced returns (lower earnings and cash flow) for a company that observes high ESG standards, its market valuations may not fall, and may rise instead. As more investors embrace ESG investing, they raise the weighting of ESG-compliant stocks in their portfolios. This bumps up the demand for ESG-compliant stocks which pushes up their prices based on the simple law of supply and demand. The market effectively prices in an “ESG premium”, as reflected in its willingness to accept a higher P/E multiple or a lower discount rate in valuing ESG-compliant companies.

• The local benchmark ESG index, i.e. the FTSE4Good Bursa Malaysia, has underperformed its benchmark index the FBM Emas persistently. We believe the key reason is the under-representation of glove stocks in the index. We hold the view that over a longer time horizon, it shall outperform its benchmark index as more investors take to ESG investing, and as the index further expands its constituents, enabling it to better represent and capture ESG-compliant stocks.

• A conservative way to play the ESG theme in Malaysia is to construct a portfolio that tracks the FTSE4Goold Bursa Malaysia Index. On the other hand, one could maximise returns by cherry-picking the constituents of the index based on their fundamentals, i.e. their growth prospects and potential headwinds, against their valuations. Our top BUYs within the constituents of the index are Tenaga Nasional, Maybank, Axiata Group, Malaysia Airports and Malayan Cement.

Source: AmInvest Research - 13 Nov 2020