19 März 2018, 17:23 GMT
This content was first published on 8 February 2018.
The wave of populism engulfing the West could have a profound effect on the corporate world and the entire ESG spectrum - on environmental, social and governance aspects - but the market has yet to fully appreciate this risk and, specifically, the risks posed by economic populism. In our view, the markets are not fully reflecting the possibility that developed markets are in early stages of a swing in the pendulum away from owners of capital back toward customers and workers.
Looking back at the Brexit vote and Donald Trump’s successful White House bid in 2016, the equity and debt markets experienced a strong negative jolt, but then quickly recovered. Indeed, investors seem to have concluded these events are positive for the underlying economies. US shareholders - emboldened by the large tax cuts passed at the end of 2017 - have pushed the Dow to unprecedented levels.
Despite the markets’ continuing bull run, the underlying causes of the surprise political upsets have not gone away: in particular, stagnant wages, economic disruption and the idea that the benefits of the free markets and globalisation haven’t been fairly shared. On the margins, we are beginning to see some incipient attempts to address these imbalances, and not all shareholders will win in this brave new world.
The UK utility industry is a case in point. The crescendo of voices on energy affordability - in the context of high shareholder and private equity returns - led all 4 major UK political parties to champion energy price caps in the 2017 snap election. Even the Conservative Party has embraced the idea and are now pushing through legislation to reduce retail energy bills for a large percentage of the population.
Political pressure has also extended into the regulated water utility sector, with the regulator Ofwat proposing a record low return of 2.3% for the next tariff period. This has caused water utility stocks to fall by 25-30% in just 6 months. Internally, I have turned negative on the sector, in anticipation of a very challenging tariff review, which will bring more headline risk and put pressure on credit metrics and ratings.
UK utilities could be a canary in the coal mine, i.e., economic populism could increasingly impact the corporate and ESG world and, by extension, investor returns. The impact may not always manifest as lower tariffs - for example, some companies may undertake lower dividends and higher reinvestment, materially increase labour costs and benefits, or be forced to relinquish market share.
Either way, with Fidelity’s research-driven approach, we seek not only to understand current ESG risks, but to prepare for them before they materialize and to engage with company management teams in our role as responsible investors.
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