August 9, 2020
Whilst Fairlight’s primary objective is to deliver superior investment returns to clients, we believe this can be achieved in an ethically aware manner. Consequently, Environmental Social Governance (ESG) considerations represent an important part of our process.
Many investors would recognise Boohoo from our presentation slides where we noted it as perhaps the most egregious ESG risk amongst the companies we have analysed. Catering to the ‘Tiktok generation’, Boohoo is the fastest growing fashion company in the UK. By skilfully employing social media influencers coupled with local manufacturing processes, this agile business has bypassed the burden of owning or distributing through traditional shop front retail. In doing so, it has built a highly profitable direct to consumer platform generating Earnings Per Share (EPS) growth of 20% pa over the past five years. However, the company known for its £10 dresses may have been caught cheating. Boohoo management has allegedly been turning a blind eye to malfeasance within its supply chain where suppliers were paying employees as little as £3.50 per hour, far below the £8.72 mandated minimum wage. Below we look at some of the red flags that resulted in Boohoo being screened out of our investment universe.
Environmental: Approximately 10% of the world’s productive energies go into clothing manufacturing, making textiles one of the heaviest polluting industries globally. Cotton farming comprises 3% of the world’s farming acreage, however, conventional cultivation uses 25% of the world’s insecticides and 10% of the world’s pesticides. Furthermore, synthetic clothing fibres blended with cotton make up circa 35% of the micro plastics in the ocean. Fast fashion garments are designed to be worn sparsely and discarded quickly, intensifying the already heavy toll fashion places on global resources.
Social: It is difficult to fathom that a company can sell a bikini for £6 and generate a gross margin double that of market leader ASOS whilst also treating those in its supply chain fairly – especially when manufacturing is conducted in the UK where labour costs are comparatively higher than emerging markets. Furthermore, non-compliance with anti-slavery legislation in Leicester has been an open secret for years.
Governance: Boohoo is listed on the UK’s secondary exchange, AIM, thereby escaping most of the mandatory governance provisions the larger exchanges are subject to. Whilst understandably, smaller businesses may find the reduced red tape burden attractive, most respectable companies will make the move to the main exchanges when scale and the ability to invest in corporate governance is achieved. In June 2020, Boohoo was the largest company by market cap listed on AIM, raising alarm bells amongst the team. Independence of the Board of Directors is questionable, as are related party transactions - at the time of AIM admission in 2014, Boohoo was buying 40% of its product from family companies. It has since engaged in several related-party property and business transactions.
Patagonia: An authentic example of ESG efforts
The Boohoo case is perhaps obvious, however monitoring broad ESG compliance across the market is not easy. Few who have read “Let My People Go Surfing” by Yvon Chouinard would question the authentic intentions of Patagonia, especially with his company’s admirable mission to “Build the best product, cause no unnecessary harm, use business to inspire and implement solutions to the environmental crisis”. Yet, trusting that Patagonia is strictly compliant with its decree of using purely organic cotton, and fair working conditions within its partners operations, requires quite a leap of faith.
Despite being the gold standard in supply chain sustainability, there are inherent conflicts of interest and opaqueness apparent in Patagonia’s monitoring systems. Patagonia, like many other high-profile retailers including Nike, use third party certifier “Fair Labor Association” to monitor supplier compliance. The FLA bases its monitoring on voluntary codes of conduct, which vary company to company and code to code. Companies inspected by the FLA choose the factories to be inspected and the individual monitors used. The FLA, after the initial period does not require a set number of factories to be inspected - the number of inspections and factories chosen are limited with incentive to be biased. If investors cannot be certain that Patagonia’s supply chain is fully compliant, then what hope do they have with more aggressive companies like Boohoo?
The Fairlight View
Greenwashing is rife throughout the funds management industry, as highlighted by the Boohoo scandal. A chorus of ‘ethical funds’ held Boohoo within their portfolios, despite the obvious signs of risk through all levels of the ESG process. Fairlight continues to take a pragmatic and research-driven approach to its ESG screening process. We employ both hard screens (tobacco, armaments etc.) whilst also scoring our investee companies across 15 distinct inputs. Whilst we fall short of professing to be ESG specialists, we suspect we may be more compliant than many of our competitors making such a claim.