Can ESG Investors Deliver A Sustainable Dividend Yield

There is no doubt environmental, social and governance (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 dividend yield?

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

See also: What is the thematic approach to ESG investment? – How to align your personal values with an investment strategy

Oil and gas firms, for example, are grappling with the dynamics climate change and decarbonisation present for their long-term strategy. And if 2020 taught us anything, it is that headline dividend yields can prove 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 will be hard to achieve anytime soon 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 to support 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 Group has a broad exposure across energy transition enabling activities, in particular renewables and electricity grid infrastructure.

Crucially, for income investors, these activities have attractive recurring cashflows 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 yield with attractive growth characteristics

We have, for many years, constructed our portfolio in three distinct categories: high dividend; dividend growth; and dividend upgrade. This has ensured our portfolio remains relatively balanced.

Leveraging the insight from our sector analysts, on-desk ESG specialist and central ESG team research, the following are examples of how we incorporate ESG within the portfolio.

High dividend
These holdings tend to be mature firms in stable industries we believe can sustainably deliver a premium yield versus the market. Some industries that have long been favourites among income investors have seen significant disruption in dividends.

For example, the shift towards renewable energy for the oil and gas sector or the implications of anti-money laundering 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 that are delivering growth by contributing positively to the momentum in ESG.

For example, Schneider Electric Global is a leading provider of solutions that improve energy efficiency, or Neste is a provider of renewable fuels that are attractive alternatives to traditional diesel.

Dividend upgrade
These holdings tend to be companies where we think dividend-paying capacity is significantly mis-priced, either because we expect dividends to inflect or the valuation to re-rate. Such holdings tend to carry more risk, which is why we limit how much capital we allocate to them. In some cases ESG forms a big 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 AG, which has one of the most compelling lines 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. It provides evidence of ESG integration in our approach towards income investing, as our allocation to best in class and leaders is 44%, whereas we own no ESG laggards at all.

This analysis provides a helpful overlay to the dividend analysis we conduct on all our holdings.

Tom Dorner is investment director of European equities at Aberdeen Standard Investments.