Avoiding a Johnson & Johnson stumble
Responsible investors can be forgiven for feeling more than a little schadenfreude over Johnson & Johnson’s tumble on US markets before Christmas.
The US healthcare giant saw around US$40 billion ($54b) wiped from its sharemarket value in a single day following reports that it knew batches of its iconic baby powder were contaminated with asbestos, a known carcinogen. And since then the rout has continued.
But for responsible investors, those that consider a company’s environmental, social and governance (ESG) performance alongside traditional financial measures such as revenue growth, profit, loss and balance sheet strength, the reports contained nothing new.
Sustainalytics, a leading global provider of ESG research and ratings to investors, has warned for several years that Johnson & Johnson’s governance in connection with a range of products, including its talcum powder, is poor (even if the company rates highly on many other ESG metrics).
The firm said Johnson & Johnson’s management of product governance has been below industry standards and it has been repeatedly involved in severe controversies related to at least eight product lines.
The company is still facing more than 100,000 legal claims related to alleged side effects on patients of at least eight of its product lines.
In addition to talcum powder, Sustainalytics highlighted issues related to products ranging from vaginal meshes, hip replacement devices, and medications such as the anticoagulant Xarelto and the antipsychotic Risperdal. It further went on to note that the issues over talcum powder warranted its highest “Category 5” controversy rating.
Under the investment process for Pathfinder’s Responsible Investment Fund, any company that attracts such a controversy rating must be excluded from the fund. We believe it signals an unacceptable risk to the company's profitability and therefore unacceptable risk of losses to those who entrust us with their capital. Indeed, we looked at Johnson & Johnson as far back as 2016, but we decided against including it in our fund for this very reason.
We are not alone. Responsible investors around the world adopt a similar approach.
The use of such controversy screening in investment selection is based on the assumption that the exposure of poor practice in one area of a company’s operations may reveal a deeper culture of poor practice.
As more issues come to light, responsible investors assign higher and higher certainties to those assumptions and therefore assess a greater risk of serious loss. These are not ratings that are considered in traditional investment frameworks, which typically draw their inspiration from measures of financial performance.
The ratings make intuitive sense. There is a share market aphorism that “downgrades come in threes”. This has certainly proved to be true with respect to companies such as Fletcher Building and Orion Health, which have repeatedly disappointed New Zealand investors.
This also suggests that any company claiming a return to the “straight and narrow” should not immediately be taken at its word.
How companies interact with consumers and society generally, rather than their suite of policy documents and their public pronouncements, is what really matters.
The success of analytical tools such as these also explains the huge growth of responsible investing in recent years. According to the US Forum for Sustainable and Responsible Investment assets under management using ESG strategies in the US grew from US$8.7 trillion at the start of 2016 to US$12.0 trillion at the start of 2018, a 38 per cent increase. And now one in every four dollars in the US is invested in funds that deploy these strategies.
Investors here are making similar demands. According to a survey by Responsible Investment Association of Australasia seven out of ten New Zealanders say they want their KiwiSaver managed ethically and to have ethical investments.
Vocalising a growing investor sentiment, Larry Fink, chief executive of Blackrock, the world’s largest fund manager, argues companies should serve a social purpose. This means being conscious of shareholder interests and also other stakeholders like employees and the community.
Companies should adopt this approach, not only because it’s the right thing to do, but also because it’s good for business. It is better for brand strength, customer loyalty, employee engagement and long-term business sustainability. More importantly, a company caring about these matters is more likely to deliver strong longterm financial performance. John Berry is co-founder and chief executive of Pathfinder Asset Management, a specialist responsible investment fund manager. He is also a member of the Governmentappointed Financial Advice Code Working Group.