More and more investors are considering ESG (environment, social and governance) in the composition of their investment portfolio. Yet this is not new. It goes back to the 1960s, when investors began to prize social responsibility. For example they refused to invest in companies with ties to South African apartheid. As deep as ESG’s roots run, the concept as we know it took hold in the mid-2000s and was codified in a 2004 report from the UN. Then and now, ESG is based on the idea that corporations have the power, and the responsibility, to effect change. But does this also make a change in the wallet of the ESG investor?
WHAT IS ESG INVESTING?
Droughts, food insecurity, and rising temperatures have a domino effect on the environment that impacts multiple sectors. As a result, investors want to address those new risks and take action to prevent them. ESG investing is their solution.
ESG means “environmental, social and governance,” representing a more stakeholder-centric business approach. ESG is set on the principle that the environment is only one factor in determining an organization’s commitment to sustainability.
Companies that adhere to environmental, social and governance standards agree to conduct themselves ethically in those three areas and can draw on various strategies, tactics and ESG solutions. As ESG increasingly becomes top of mind for directors, it’s essential to consider the global nuances that drive focus region by region.
ESG strategies are more widespread than you might think. The following are prime ESG examples:
Environmental examples:
- Minimizing your carbon footprint to fight climate change
- Reducing greenhouse gas emissions
- Using renewable energy throughout your value chain
Social examples:
- Giving back to the communities in which you operate
- Creating an equitable and safe working environment
- Treating your customers with dignity and respect
Governance examples:
- Offering pay transparency and pay equity across your organization
- Assembling a diverse board of directors
- Holding employees and leaders accountable for unethical practices
According to a report by PWC, the practice of ESG investing has grown over the last few years. The report states that the ESG asset pool will continue to grow rapidly and become essential in the investment process in the coming years.
WHY IS ESG INVESTING IMPORTANT?
ESG investing is important in many ways. 80% of the world’s largest companies have reported exposure to climate change-related risks, while climate-related events could cost those businesses $1.6 trillion by 2026. ESG is an important way to insulate against those risks.
ESG investing is also financially important. In a recent study, MSCI investigated the ties between ESG investments and the stock market, to see if there were any financially significant effects. The study used a three-channel model to look at how ESG data embedded in stocks gets transferred to the equity market.
The study found that, after examining idiosyncratic and systematic risk profiles for the companies involved in the study, ESG affected many of those companies’ valuations and performance.
Companies with higher ESG ratings showed:
Higher profitability
ESG companies with high ratings showed abnormal returns and were more competitive. This often led to higher profitability and dividend payments, especially when contrasted against low ESG companies.
Lower tail risk
High ESG-rated companies experienced fewer idiosyncratic risk events like major drawdowns. Companies with low ESG ratings were more likely to experience these incidents.
Lower systematic risk
High ESG companies had less volatile earnings and less systematic volatility. They had lower betas and lower costs of capital than low ESG-rated companies.
They also displayed lower instances of bribery, fraud, and corruption over time. These results suggest that, in the long run, ESG investments are more stable and can even outperform other companies.
IS ESG A GOOD THING, MYTHS DISMANTLED?
Though ESG is important and a priority for many, it’s also controversial. This backlash, though, is largely tied to ESG myths that are easily misunderstood but are even easier to debunk. Here are some persistent myths dismantled.
ESG is a poor use of resources?
For most companies, adopting ESG principles will require an up-front investment. That investment often pays for itself, though, given that it can also cut costs by reducing employee attrition, lowering the risk of penalties for noncompliance and stabilizing the supply chain.
ESG isn’t a good investment?
Here are lawmakers, investors and even corporations who claim that investing based on ESG isn’t profitable. However, intangible assets like reputation account for more than 80% of an organization’s S&P asset value, and Stock prices of companies with high ESG rankings also tend to be less volatile, whereas “high ESG controversy” events can cause a company’s stocks to underperform the market for as long as two years.
ESG is too difficult to track?
Because ESG is multi-faceted, some feel that it can be difficult to truly track and manage. How can someone really know they’re making a sound ESG investment? While corporate ESG practices have evolved, they are currently quite strong. Many boards leverage ESG tools, and 90% of S&P companies have an ESG strategy, making ESG trackable and transparent.
People used to believe that ESG investments were a sacrifice, an investment more morally than economically motivated. Today, that isn’t necessarily true. When it comes to ESG there can be multiple wins.
Win for society
ESG investing may drive the search for solutions to the many challenges we face, from climate change to human rights violations to equity in the workplace.
Win for investors
ESG performance has been shown to correlate strongly with financial performance. Companies in the S&P 500 that ranked in the top quintile for ESG factors outperformed those in the bottom quintile by more than 25 percentage points between the start of 2014 and the end of June 2018.
Win for corporations
ESG is a business opportunity for open-minded corporations, as these issues shape consumer expectations. Among millennials, 83% of consumers support brands that align with their values.
Win for governments
Increased focus on ESG across the business and political spectrum has made this a vital issue for governments, exemplified by imperatives like the publication of the 2021 IPCC report on climate change that renewed the ESG focus.
CONCLUSION
ESG investment started in the 1960s. While certain ethical concerns have changed, the principle of sustainable investing remains the same. More and more investors are adopting ESG criteria, evaluating their potential investments with an emphasis on how effectively corporations navigate people and planet, not just profit.
According to a report by PWC, the practice of ESG investing has grown over the last few years. The report states that the ESG asset pool will continue to grow rapidly and become essential in the investment process in the coming years. It is clear, the next generation is changing the way investment works, thus creating more opportunities for Impact
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