A fund manager’s view – an alternative way to invest responsibly

Society’s path to Net Zero is the most challenging joint enterprise that we’ve ever faced. History is full of advances achieved through people throwing energy at problems. Ships, trains, cars, and trucks. Airplanes and rockets. All powered by fossil fuels. Cities lit by the light from coal powered electricity. Factories running on the same.

A huge slice of global emissions comes from industry and big business. So it’s no surprise that investors are becoming more conscious about who and what they finance. The rise of responsible investment is only beginning. Environmental, Social and Governance (ESG) funds have been around for many years. 'ESG' has become the label for funds following sustainable or responsible investment strategies.

How do people usually invest responsibly?

There are lots of approaches to responsible investing.

Some investors might use, or in invest in a fund that uses, negative screening to be a responsible investor. This is where you exclude certain companies or industries from your 'investable universe'. For example, you might refuse to invest in oil or tobacco companies.

The opposite of this is positive screening. With this approach, investors will look to back companies that have scored well on ESG factors.

There's also thematic and impact investing. Thematic investors will focus on a particular theme within ESG. Then they would invest in companies that follow that theme. For example, a thematic investor might focus on renewable energy as a theme.

An impact investor looks to generate positive, measurable social impact with their investment, while also looking for a financial return.

But these aren’t all of the ways and approaches to responsible investing.

Thinking long-term in a new world

There is another way to think about responsible investing. We can think about a company's cash flow. How much cash are they generating? What in their business model will drag cash flows down? Will they be able to generate cash in the transition to a Net Zero world?

Companies able to generate resilient, consistent cash flows are always in demand. And in a Net Zero world, they could be worth even more.

So what do these companies look like?

Companies that are able to set their own prices are good examples. With pricing power, they stand a better chance of generating cash. If they can do this while keeping running costs low, they can have bigger profit margins. This pricing power is sometimes coupled with owning intellectual property (IP). Business models that centre on recurring revenues match this description as well. It gives investors better visibility of a company's income and how sustainable it is.

Companies that don’t fit this description might have demands to reinvest money. They might have to spend money on physical capital like machinery or buildings.

This approach would avoid big factories with big carbon footprints. Businesses with these would have to put money into physical capital often.

In the path to Net Zero, lots of these companies will need to spend huge sums of money. They will need to clean up their operations and maintain day-to-day investment levels. Cash-generative, capital-light businesses however will be much better placed.

That’s because companies with surplus cash can afford to invest in the transition. And they can do it faster than those with weaker cash flows. This will improve their competitive position in the road to Net Zero.

The path to Net Zero is going to make businesses become more responsible and sustainable. Investing in companies that can make this change is one way to invest responsibly. All without having to dive into the minutia of ESG metrics and scoring systems.

This article isn’t personal advice. If you’re unsure about what to do, ask for financial advice. All investments fall as well as rise in value, so you could get back less than you invest. The HL Select funds are run by our sister company Hargreaves Lansdown Fund Managers Ltd.

How HL Select approaches responsible investing

When we launched HL Select, we wanted to pick the most promising stocks we could find.

We had a clear strategy. To identifying high quality, cash generative businesses, with robust finances.

This type of investment philosophy and way of managing funds, should be well suited on the path to Net Zero.

Find out more about HL Select