31 Jul ESG: Environmental, Social and Governance. The Way Forward
Environmental, Social and Governance (ESG) – a set of standards for a company’s operations that socially conscious investors use to screen potential investments – which takes into account the integration of environmental, social and governance factors, is paving the way forward (https://www.forbes.com/sites/georgkell/2018/07/11/the-remarkable-rise-of-esg/#63453f3d1695) (https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp).
The above statement is suitably depicted by the fact that as of July 2020, ESG investing – also known as responsible / ethical investing – is estimated at over USD 20 trillion in Assets Under Management or around a quarter of all professionally managed assets around the world.
ESG investing has grown strongly over the last few years, whereby according to data from Morningstar, annual European sustainable fund flows increased from EUR 50 billion in 2018 to a record-breaking EUR 120 billion in 2019, bringing the total assets under management to EUR 668 billion (https://www.ftadviser.com/investments/2020/07/13/the-main-principles-of-esg-investing/) (https://www.ft.com/content/1cfb5e02-7ce1-4020-9c7c-624a3dd6ead9).
The term ESG, which was first brought about in 2005 in a landmark study called “Who Cares Wins”, is defined as “a generic term used in capital markets and used by investors to evaluate corporate behaviour and to determine the future financial performance of companies”. It is also perceived that ESG “are a subset of non-financial performance indicators which include sustainable, ethical and corporate governance issues such as managing a company’s carbon footprint and ensuring there are systems in place to ensure accountability” (https://www.esg.adec-innovations.com/about-us/faqs/what-is-esg/).
Environmental factors determine a company’s stewardship of the environment and focus on waste and pollution, resource depletion, greenhouse gas (GHG) emissions, deforestation, and climate change. Additionally, social factors look at how a company treats people and focuses on employee relations and diversity, working conditions, local communities, health and safety, and conflict.
Lastly, governance factors take a look at corporate policies and how a company is governed, and they focus on tax strategy, executive remuneration, donations and political lobbying, corruption and bribery, and board diversity and structure.
ESG investments have gained prominent attention as it is now regarded as “safe havens” by the majority of investors, according to deVere Group, one of the world’s leading independent financial advisory and fintech organisations (https://www.financialmirror.com/2020/07/23/56-of-investors-see-sustainable-investments-esg-as-the-new-safe-haven/).
Mr. Nigel Green, deVere Group’s CEO and founder, has stated that “It’s a phenomenon that’s particularly prevalent with millennials, with eight out of ten putting ESG credentials at the heart of their investment decision-making process”. This runs parallel with the fact that 84% of millennials give importance to the ESG impact, according to a Morgan Stanley survey, as millennials are poised to inherit over USD 68 trillion from their predecessors by 2030, which is five times of the wealth they have today (https://www.nasdaq.com/articles/the-rise-of-esg-investing-top-esg-etfs-to-invest-in-2020-07-06).
It is important to note that internal studies show that 56% of clients who seek to include environmental, social and governance-orientated investments into their portfolios do so citing that such sustainable funds offer financial protection in times of uncertainty (https://www.financialmirror.com/2020/07/23/56-of-investors-see-sustainable-investments-esg-as-the-new-safe-haven/).
Many multinational companies have paved the way by incorporating ESG in their framework. A notable example is Microsoft, in early 2020, when it set a target to be carbon negative by 2030, and by 2050 it is committed to remove all the carbon from the environment the company has emitted since it was founded. Other companies have made similar announcements, such as Salesforce and Starbucks (https://www.nasdaq.com/articles/the-rise-of-esg-investing-top-esg-etfs-to-invest-in-2020-07-06).
Moreover, the Covid-19 pandemic has highlighted the advantages of ESG integration for both asset managers and corporates in identifying specific areas that can be beneficial to financial performance (https://www.theasset.com/covid-19/41117/covid-19-highlights-advantages-of-esg-integration).
In relation to asset managers, those in a more advanced stage of integrating ESG factors into their investment strategies and portfolios are in a better position to identify companies that can perform better than their peers during and after the health crisis. Regarding corporates, those undertaking ESG integration into their business models and operations have benefited from being in a stronger position to withstand the immediate impact of the pandemic as well as its longer-term effects.
The shift towards the trend of ESG is indisputable, taking into account that not too many years ago it was perceived that profit and corporate social responsibility were mutually exclusive pursuits, whereas now, over the past decade, funds that incorporate environmental, social and governance concerns have outperformed non-ESG funds. It is evident that doing good is good for business (https://www.forbes.com/sites/deloitte/2020/01/21/why-doing-good-is-good-for-business/#4daef6616b29) (https://www.ft.com/content/b4a112dd-cafd-4522-bf79-9e25704577ab?segmentId=b0d7e653-3467-12ab-c0f0-77e4424cdb4c).