ESG: Investing for the future
ESG is an increasingly popular theme of investing that seeks to create a long-term positive impact upon society by changing the criteria with which we evaluate the suitability of a company for investment, as outlined in our separate Guide to ESG Investing.
It is a key part of the new drive for sustainable investing, which comprises not only ESG investing but also Socially Responsible Investing (SRI) and Impact investing.
ESG refers to the environmental, social, and governance practices of a company or sector that may have a material impact on the performance or suitability of the prospect in question for investment.
By supplementing our traditional ratio/financial analysis of potential investments with ESG factors, we can identify potential risks and opportunities that would previously have remained unknown.
While there is a broad theme of social consciousness, the main aim of ESG valuation is to further refine and optimise financial performance on opportunities that have already been clarified as profitable investments.
Socially responsible investing (SRI) is a little more active in style than ESG. Also known as ‘ethical investing,’ it proactively seeks to eliminate or select investments according to specific ethical guidelines. The underlying motive could be religion, personal values, or political beliefs for instance.
Unlike ESG analysis which shapes valuations, SRI uses ESG factors to apply negative or positive screens on the investment options available and is thus a little more clear cut.
In Impact or Thematic investing, positive outcomes are of the utmost importance, hence the name, meaning the investments need to have a positive impact in some way. Thus the objective of impact investing is to help a business or organisation accomplish specific goals that are beneficial to the wider society or the planet.
The New Normal
Earlier in the year, Larry Fink, the CEO of the world’s largest asset manager, BlackRock, stated that “climate risk is an investment risk” and that his company would incorporate climate risk into their risk management process alongside the usual investment risks considered such as currency, political, market or inflation risk…to name a few.
ESG investing’s sharp upward curve in demand is unlikely to flatten any time soon, particularly as some of its strongest advocates, Millennials, are about to inherit a significant amount of wealth from their older relatives in what has been dubbed ‘The Great Wealth Transfer.’
It is expected that somewhere in the region of £5 trillion will pass from Baby Boomers to their children in the coming years.
Much of the research on the Millennial generation and their investing aims shows that nearly all of them (90%) wish to invest according to ESG values, with a large number already doing so.
The Bank of America Corporation estimates that, collectively, funds with ESG themes and aims will rival the S&P 500 in the USA within the next twenty years, anticipating growth to $20 trillion of assets.
Among the various misconceptions associated with environmental, social and governance (ESG) investing, perhaps the most persistent is the belief that prioritising ESG factors correlates with financial underperformance.
But with the costs and benefits of global crisis mitigation becoming clearer – and the potential value and resilience of ESG stocks increasing in evidence – the reality may be quite different, as highlighted in Rathbone Greenbank’s Insight “ESG Investing – doing good, without compromising on financial performance”.
ESG is most certainly a new normal that isn’t going away anytime soon, and what an exciting new normal for investors to participate in.
How does it work?
As mentioned, the investor in question will look at additional investment criteria if they wish to engage in ESG investing. There are three factors to ESG investing that are examined.
Firstly, Environmental factors are studied to determine how well a company’s activities benefit the environment, with a particular focus on halting waste and pollution, preventing resource depletion, reducing greenhouse gas emissions, halting deforestation, and limiting climate change.
Environmentally positive outcomes include avoiding or minimising environmental harm as a result of a company’s activities, lowering costs and thus increasing profitability through a switch to cleaner energy sources, and reducing regulatory, litigation and reputational risk.
Second, Social factors look at how a company treats people, both internally and externally. There is a focus on employee relations and workforce diversity, the working conditions themselves, how the company interacts with and benefits the local community, and its overall record on health and safety and human rights.
Socially positive outcomes include increasing productivity and morale, reducing employee turnover and absenteeism, and improving brand loyalty.
Lastly, Governance factors take a look at corporate policies and how a company is led. They focus on tax strategy, levels of executive remuneration, donations and political lobbying, corruption and bribery, and board diversity and structure.
Governance positive outcomes include aligning interests of shareholders, management and all employees, and avoiding unpleasant surprises as we have seen with the recent Wirecard fraud scandal.
ESG metrics are not commonly part of mandatory financial reporting, though companies are increasingly making disclosures in their annual reports or in a standalone sustainability report.
The CFA Institute has formed a working group to develop an ESG investment product standard that would build a framework for investment managers to better communicate, and their clients to better understand, the nature and characteristics of ESG-centric funds and investment strategies.
How can I get involved?
Since the turn of the century, the number of news articles with a sustainable investing theme has risen steadily, alongside the number of signatories to the UN’s Principles for Responsible Investment, which nine in every ten of the world largest fund managers have now signed.
Additionally, according to a Schroders index, the amount of assets under management in their European responsible investment fund has risen steadily since the early 2000s.
Indeed, the wealth management arm of Schroders, Cazenove Capital, who are themselves a member of our network, have very recently beaten a field of 60 other investment groups to win the “ESG investing Olympics”, an event that aimed to find the best-in-class sustainable fund manager.
If you are keen to learn more about ESG investing, read our guide as referenced at the start of this article or have a listen to the two podcasts below on the topic that we have selected.
At The Wealth Consultant, we are able to utilise our extensive network of individual wealth managers to find a selection that suits not only your immediate investment needs, but any ESG aims that you may have as discussed above.
Whether you are looking for a wealth manager who specialises entirely in ESG investing, or wish to incorporate some stricter ethical guidelines into your portfolio in line with your own beliefs, we will be by your side to find the best solution.
Let us work with you to bring you financial peace of mind, whilst ensuring that we change the world for the better in the process, and grow back from our current global situation greener and happier.
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