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Recognising ESG opportunities for income investing

UK: Suitable for retail and professional clients.

Date: 04 October 2021

Bethan Dixon explains:

As the world adjusts to the new normal post-covid, investor focus on the broad set of risks faced by global companies and particularly how they manage their environmental and social risks is increasing. Bethan Dixon, portfolio manager at Quilter Investors, looks at how income investors can take advantage of the new opportunities resulting from the consideration of ESG (Environmental, Social, and Governance) factors.

Last year was a challenging one as the pandemic significantly changed how we all lived our lives and how companies conducted their business. It was a particularly tough year for income investors, as this disruption resulted in dividends being cut significantly in the UK and Europe.

The pandemic continues to cause uncertainty and has unsurprisingly increased investor focus on the broad set of risks faced by companies and how prepared these businesses are to deal with other large-scale events, such as the impact of climate change.

ESG in the spotlight

Recent events have raised the profile of how investors consider environmental and societal impacts when allocating capital and how they assess a company’s performance at managing these risks.

In 2020, while many dividends were cut as companies sought to protect balance sheets – in an effort to survive the shorter-term disruption to their business activities – companies also came under pressure to consider the societal impact of continuing to reward shareholders through dividends, while reducing the size of their workforce or receiving government support.

Last year, Royal Dutch Shell and BP both reduced their shareholder payouts, which while disappointing for income investors, does provide hope that this will allow the companies more flexibility to decarbonise their business models and play a pivotal role in the creation of a low carbon energy system.

30%
There was also a focus on protecting biodiversity and tackling deforestation, with the formation of the G7 Nature Compact targeting the conservation or protection of at least 30% of global land and at least 30% of the world’s oceans by 2030.

Spotting new opportunities

While the focus on ESG considerations may be creating headwinds for company cashflows and dividends that originate in the ‘old economy’, it is also presenting a number of investment opportunities in areas that can generate strong sources of income such as renewable energy and infrastructure assets.

The recent G7 summit in the UK saw the major developed economies reaffirm their commitment to the Paris Agreement and commit to increased targets for cutting emissions by 2030, as well as reaffirming the target of net zero emissions by 2050 at the latest. The plans include increasing energy efficiency, accelerating renewable and other zero-emissions energy deployment and adopting stricter measures on burning thermal coal while supporting developing countries in their transition away from coal power.

There was also a focus on protecting biodiversity and tackling deforestation, with the formation of the G7 Nature Compact targeting the conservation or protection of at least 30% of global land and at least 30% of the world’s oceans by 2030.

This increased focus by governments to tackle the climate crisis should result in a significant shift in capital that will present investment opportunities.

The renewable energy sector is well established and already provides strong income opportunities, with the sector likely to continue expanding given the pivotal role renewable energy and related infrastructure will play in a low carbon energy system.

Meanwhile, the coronavirus pandemic is a healthcare crisis that has highlighted the fragility of healthcare systems globally. Prior to the pandemic, there was already a clear need for greater investment in healthcare systems, particularly in developed nations to deal with the increased healthcare demands of an ageing population.

There are a number of real-estate investment companies that work with national healthcare providers to deliver the infrastructure required to support the provision of quality healthcare. These companies can provide opportunities for income-seeking investors, given the nature of the cash flows generated by these assets.

Looking to the future

The coronavirus pandemic has certainly increased the focus on how companies manage these broader and less tangible risks.

While the global health crisis has made healthcare a priority once more, areas such as renewable energy have already developed significantly over the past few years, and this is likely to continue as tackling the climate crisis and managing the climate transition remains high on the agenda for governments, company boards and investors.

For income investors, it is important to consider this wider picture and the potential impact these risks might have on a company’s future income profile. Therefore, diversifying income streams and seeking out new opportunities for long-term income is key.

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Bethan Dixon

Portfolio Manager

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