ESG leaders are more likely to offer long-term dividend growth says Matthew Jennings, Investment Director at Fidelity International.

New research from Fidelity shows a positive link between a company’s sustainability and historical dividend growth. It suggests that ESG leaders are more likely to offer better dividend growth over the long term, across a range of economic scenarios with Fidelity’s sustainability ratings (which grade c. 4,900 companies from A to E) showing a strong relationship between historical dividend growth and ESG quality.

On average, companies rated A for sustainability have the highest levels of historical dividend growth, at over 5 per cent, with D- and E-rated stocks offering the lowest average levels of growth. The trend is not entirely linear because the smaller sample for E-rated stocks allows for individual companies to skew the median more than in other ratings groups.

Fidelity says that good management of environmental and social risks tends to help companies avoid higher regulatory costs, litigation, brand erosion and stranded assets. Strong governance, meanwhile, reduces the risks associated with over-leveraged balance sheets or risky, value destroying M&A. This protects profits and allows them to be paid out to shareholders as dividends.

However, companies in sectors with structural sustainability issues – whether well managed or not – may face weaker dividend growth. For example, oil majors Shell and BP both significantly reduced dividend distributions last year to fund the transition to lower carbon assets. By contrast, utilities with renewable energy operations are benefiting from regulatory and investment tailwinds. Enel, one of the earliest utilities to invest a lot of money in renewable energy and now the largest renewable provider in the world by power output, has committed to 7 per cent annual growth in dividends through to 2023. In a completely different sector, Unilever – another business Fidelity rates highly for sustainability – has a strong record of long-term dividend growth (around 6 per cent annualised over 20 years).

Given their superior dividend growth prospects, one might expect stocks rated highly for sustainability to trade at significantly lower dividend yields. Encouragingly for income investors, this does not seem to be the case. The difference in yield between the highest and lowest ESG-rated stocks is modest, and certainly manageable within the context of a broad investment universe such as global equities. Some ESG leaders even offer yields that match or exceed those of lower-rated stocks. For example, Enel currently offers around 4.5 per cent dividend yield, and Unilever around 3.5 per cent.