Interview: ESG simplified: Unlocking financial potential with Naomi Waistell, Polar Capital

A deeper shift towards investments that positively impact society and the environment while also offering solid financial returns. Naomi Waistell, senior fund manager, global emerging markets, Polar Capital, shares her insights with Piyasi Mitra.

Polar Capital’s emerging markets & Asia team has incorporated ESG analysis into its investment process. How does this integration of ESG factors practically affect financial assessments and decisions, and why should it be considered financially relevant?

There’s a misconception regarding ESG factors as being labelled non-financial by the market or standard approaches. ESG factors are investment factors integral to bottom-up, fundamental analysis, much like traditional financial characteristics. For instance, a company facing a health and safety controversy can incur a reputational cost, impacting its top line. This affects revenue and may lead to compensation payouts, employee attrition, or increased wages, impacting various aspects of the profit and loss statement. At Polar Capital, we adopt a holistic approach, quantitatively incorporating these factors into our valuations. 

How do ESG factors influence an investment team’s assessment of a company’s growth rate assumptions, competitive position and the discount rate applied in financial models?

True sustainability, as we see it, goes beyond the prevalent green agenda and planet-saving narratives; it revolves around a company’s resilience and its enduring competitive advantage. By proactively addressing and managing the entire stakeholder environment, a company can potentially outperform its peers, mitigate operational ESG risks, and secure a more extended business duration. This approach results in a superior life cycle and heightened economic profit. Conversely, companies neglecting these factors may experience lower growth, heightened risks, and a shorter competitive advantage, warranting a lower valuation.

How can responsible investing strategies effectively balance financial returns with environmental and social impact, and what are the key metrics or indicators used to evaluate this balance?

 We aim to enlighten investors for the next generation, emphasizing that responsible investing entails no compromise. Properly executed, integrating ESG into valuations should enhance returns. The misconception that sustainable investing involves sacrificing returns is unfounded. The UN Principles for Responsible Investment (PRI) principles define ESG integration as improving risk management and returns by incorporating relevant factors into investment decisions. It’s about achieving financial returns while investing sustainably. Analysing material factors is generally accepted and should focus on critical elements that significantly impact a company financially or operationally. Both management teams and investors should dedicate their time to improving and analyzing factors that are pivotal to the business.

In responsible investing, what challenges and opportunities arise when considering different industries or sectors, and how can investors navigate these complexities to make informed and ethical investment decisions? Can you please explain with examples?

 In examining the E, S and G aspects individually, their development, data availability, and investor assessments vary. These factors also manifest differently across diverse emerging markets, reflecting considerable heterogeneity. For instance, while a diverse shareholder base benefits governance, we prefer investing in contexts with a large, controlled shareholder—such as a family or founder deeply invested in the business—enhancing alignment with our interests. Our investment approach emphasises checks and balances, seeking alignment in motivation, expertise and robust governance structures. We prioritise entities with sound incentive structures, particularly in countries like Mexico, India or Taiwan, where governance principles align prominently. Environmental considerations, especially concerning climate change and greenhouse gas emissions, play a pivotal role in our decision-making process. 

In emerging markets, considerations must account for existing infrastructure, as seen in countries like Brazil, which boasts a significant advantage with a substantial base in hydro energy. In contrast, many Asian nations, including South Korea, India and China, present a different energy landscape, demanding distinct strategic approaches. 

We exercise caution in imposing standards or targets, recognising the importance of adapting to underlying conditions. This approach offers us opportunities to engage with companies undergoing inflexion points, navigating transitions and presenting prospects for significant increases in economic profit. As companies enhance their ESG scores, we observe a correlation with a lower cost of capital. Over time, those with consistently higher ESG scores, indicative of superior performance, are financially rewarded with lower discount rates. Our strategy involves adjusting the cost of capital on a sliding scale, reflecting the inherent ESG risk observed in each company.

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