Tom Dorner

There is little doubt that ESG considerations are increasingly driving share prices and asset flows in European markets. But what does ESG mean for Income investors trying to deliver a sustainable premium dividend yield?

This question is particularly relevant since many of the highest yielding sectors that are the traditional hunting grounds for Income investors are also facing increasing ESG scrutiny.

Oil and Gas firms, for example, continue to grapple with the dynamics that climate change and decarbonisation present for their long term strategy and social license. And if 2020 has taught us anything, it is that headline dividend yields can prove to be illusory when businesses face challenges.

The global economy is shifting from carbon-intensive energy production towards lower emission renewable generation. On the current trajectory, net zero is going to be hard to achieve and we need to see a meaningful acceleration in the deployment of renewable power generation and adjacent infrastructure. In our view, this positions energy transition as a multi-decade secular trend and there is plenty of evidence supporting this, such as the EU Green Deal and President Biden returning the US to the Paris Climate accord.

Several of our European Utility holdings play a leading role in this transition. For example, Enel has a broad exposure across energy transition enabling activities, in particular renewables and electricity grid infrastructure. Crucially, for us as income investors, these activities have attractive recurring cash flows as well as investment-driven growth. This translates into a high degree of confidence in the dividend paying capacity of a business, offering a sustainable premium dividend yield with attractive growth characteristics

We have for many years constructed our portfolio in three distinct categories - High Dividend, Dividend Growth and Dividend Upgrade - which has ensured that our portfolio remains relatively balanced. Leveraging the insight from our sector analysts, on-desk ESG specialist and central ESG team research, here are some examples of how we incorporate ESG considerations within the portfolio:

High Dividend - these holdings tend to be mature businesses in stable industries which we believe can sustainably deliver a premium yield compared to the market. Some industries that have long been favourites among Income investors have seen significant disruption and disappointment in dividends.

For example, the shift towards renewable energy for the Oil & Gas sector or the implications of AML investigations for the Banks sector have posed serious challenges for Income investors. We have for some time preferred Utilities and Insurance sectors in our High Dividend category due to their superior dividend delivery.

Dividend Growth - these holdings tend to have a sub-market yield with the potential to grow their dividends faster than the market. We have found a number of companies in this category which are delivering growth by contributing positively to the momentum in ESG. For example, Schneider is a leading provider of solutions that improve energy efficiency or Neste is a leading provider of renewable fuels which are an attractive alternative to traditional diesel.

Dividend Upgrade - these holdings tend to be companies where we think dividend paying capacity is significantly mispriced, either because we expect dividends to inflect or the valuation to re-rate. These holdings tend to carry more risk which is why we limit how much capital we will allocate to them. In some cases ESG forms an important part of the investment case. For example, Siemens Energy owns a significant stake in leading turbine manufacturer Siemens Gamesa which is benefiting from growth in wind power or Daimler which has one of the most compelling pipeline of electronic vehicles in the market.

All of our stock research has had ESG analysis integrated for several years, including our proprietary ESG scoring from 1 to 5 (1 being Best in Class and 5 being Laggard). The chart below shows the ESG scoring for the holdings in our fund. It provides evidence of ESG integration in our approach towards income investing - our allocation to Best in Class and Leaders is 44%, whereas we own no ESG Laggards at all. This ESG analysis provides a helpful overlay to the dividend analysis we conduct on all our holdings. It is also worth noting that the fund has a AA MSCI ESG Rating.

Our primary objective remains the delivery of a sustainable premium yield to our clients. Embedding ESG analysis in the investment process enhances our ability to delivery on this objective as capital allocation trends in the market evolve. It also allows us to identify structural opportunities, as well as mitigate risk.