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ESG Investing: The New Frontier for Investors

by internationalbanker

By Hilary Schmidt, International Banker

A distinct trend has emerged in recent years among the global investment community. Investors are increasingly looking beyond just the pecuniary returns they could earn on potential investments; instead, many are now also concerned about the wider impact their investments could have on the world, with regards to such issues as climate change, human-rights issues and gender discrimination. Companies are selected—and also avoided—based on what likely long-term impact their business strategies will have on the environment, on society and on their governance methods. Such investing is known as ESG investing.

Sometimes referred to as “sustainable investing” or “ethical investing”, ESG (environmental, social and corporate governance) investing is an umbrella term for those investments that, in addition to aiming for positive returns, seek to have a positive and sustainable impact on the environment, society and business performance. ESG investors, therefore, will usually evaluate a company by incorporating ESG criteria into their research when screening for potential investments and assessing potential risks. But there’s not just a hope among investors that the more benevolent companies will perform well; on the contrary, a solid rationale for ESG investing exists—that companies that comply with high standards of environmental, social and governance standards should outperform in the long-run.

As far as environmental factors are concerned, such criteria will normally include evidence that the company effectively manages the overall impact from pollution, carbon emissions, climate impact, resource depletion and deforestation. Social factors, meanwhile, are concerned with how the company treats people with regards to fairness, diversity and equality in employment decisions, as well as working conditions, corporate social responsibility, and health and safety. Finally, governance factors relate to the company’s governance policies, such as tax strategy, executive remuneration, political lobbying, previous corruption issues, and board diversity and structure.

Overall, ESG has become deeply associated with investment strategies that choose sustainability factors as a way to identify companies with superior long-term business models. According to Anders Thorendal, who has been the national asset manager for the Church of Sweden since 2005 and who spoke to Forbes in August 2017, sustainability is about “identifying well managed companies that have a long-term view…and where sustainability aspects are part of their business model even though it is not necessarily expressed as sustainability”. Thorendal references the conclusions reached by Professor Robert Eccles at Harvard that such companies are more profitable over time and deliver better returns to their shareholders. A sustainability-based approach, according to Thorendal, means that a company has sufficiently identified and dealt with the risks associated with its operations.

That being said, there is no industry standard for ESG or sustainability, which means that fund managers usually set their own criteria when researching potential investment targets for their clients. For instance, Gitterman Wealth Management, a leader in ESG investing, describes a successful ESG money-management strategy involving three important steps. Firstly, identify a set of compelling investments, based on traditional investment-selection criteria. Then, apply an ESG lens to this set of viable investments. And, finally, select those investments that are anticipated to generate a scalable, profitable impact.

According to data from the US Forum for Sustainable and Responsible Investment (SIF Foundation), ESG investing has grown enormously over the past 20 years or so. In 1995, the number of investment funds incorporating ESG strategies was less than 100. By 2016, the number had passed 1,000. The net assets of such funds, moreover, have similarly grown from tens of billions to more than $2.5 trillion during the same time period.

ESG investing is proving particularly popular among the Millennial generation. According to a report by Morgan Stanley’s Institute for Sustainable Investing, which polled 1,000 individual investors in the United States, not only was sustainable investing deemed to be “entering the mainstream”, but also that Millennial investors continue to lead the charge—“they are twice as likely as the overall pool to invest in companies or funds that target social or environmental outcomes”. 

A variety of reasons can explain such startling growth. On the environmental side, climate change is now much more widely accepted, and as the Paris Agreement and major global divestment movements against environmentally harmful businesses take hold, and as environmental disclosure requirements for companies become more stringent, the shift towards responsible investing seems like a natural consequence of such shifts. Furthermore, energy markets have changed considerably in recent years, with coal production in the US on the decline, natural gas experiencing a huge price drop, and renewable energy becoming cheaper and more in demand.

What’s more, it doesn’t seem as though the demand for ESG products is going to fall anytime soon. As concerns about such issues remain in the mainstream consciousness, and also remain high on the priority lists for most companies, ESG products will only grow to represent a greater share of the investment marketplace. Just under half of companies on the Fortune 500, for instance, have set renewable energy or carbon-reduction targets, and in doing so, have confirmed that they are saving on costs.

And given the controversies that have emerged under the Trump Administration—including the US’ exit from the Paris Agreement, a rollback of environmental regulations, greater support for fossil-fuel industries such as coal and dismantling of the Environmental Protection Agency—investors are likely to be more incentivised than ever to respond to such policies by allocating their funds to ESG strategies. As a leading firm in responsible investing, Calvert Research and Management recently stated, “Where political will appears to have failed, investors and businesses are taking up the banner on issues such as climate change and diversity. We believe responsible strategies are likely to gain increasing market share for decades to come”.

Indeed, the US aversion to the Paris climate accord may have opened the door for the Asia-Pacific region to potentially become the world’s leader in ESG investing. According to a BNP Paribas study from last year on ESG activity in the region, it was revealed that 46 percent of asset owners plan to have 50 percent or more of their investments in funds that incorporate ESG or responsible investing during the next two years, while 54 percent of asset managers plan to market at least half of their funds as ESG or responsible investing funds.

That said, there exists a lack of information on industry standards for ascertaining what exactly falls under the ESG banner and how companies are “scored” on their overall impact. As such, it remains crucial for investors to ensure that their investment goals and their assessments of companies with respect to ESG are in line with that of their asset managers.


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