The idea of ESG, which stands for Environmental, Social and Governance, is becoming increasingly important within the investment world. Regulators and policy makers are encouraging the integration of ESG considerations in Discretionary Fund Managers’ investment processes, while increasing client demand for responsible investment services means that advisers can no longer afford to ignore the ESG sector.
The umbrella term ESG means different things to different people. Some will think of poor air quality and plastic everywhere, others about the demise of firms like Carillion and BHS leaving shareholders out of pocket, pensions underfunded and employees out of work. Nevertheless, everyone is affected by ESG issues in one way or another.
What is certain is that ESG considerations are becoming more popular with investors. Since the first socially responsible mutual fund, the Pax Fund, was launched in the US in 1971, the sector has expanded massively and over $10 trillion is now invested in ESG strategies around the world. This is perhaps understandable, as most people want to leave a greener, cleaner world for their children and grandchildren. They are no longer content for their investment managers to just make money, they also want their investments to have a positive influence on the world. Indeed, a recent YouGov poll showed that just 39% of UK investors are solely concerned with generating profits, whereas 47% wanted their investments to have a positive influence on society.
Despite this, not all institutional investors are as enthusiastic as the general public. The UK parliament’s cross-party Environmental Audit Committee found that of 25 large UK pension funds (with combined assets under management worth £555bn), only 12 had considered climate risks at board level. Furthermore, 5 were unable to identify one climate action they had taken. It is perhaps understandable that some institutional investors have taken a relaxed approach to ESG investing; their goals have traditionally been set purely in financial terms and it is often assumed that ESG funds are at an immediate disadvantage because they may avoid investing in certain types of business, such as alcohol, tobacco, gambling, defence, pornography, and even oil. However, this view appears to be increasingly outdated.
The development of ESG investing
Today, ESG investing has become about more than simply detecting unsustainable business practices, it is now as much about identifying positive traits within a business. The companies of the future will have to provide solutions for a world with scarce resources, where both investors and customers are concerned about the effects of climate change. In this world, social and legal barriers will have increasingly large effects on the profits that businesses can generate from certain activities. Companies that consider ESG factors in their decision making will therefore have a better chance of developing competitive advantages, potentially allowing them to produce superior investment returns. Ultimately, the link between ESG considerations and financial value creation will have to be recognised more clearly.
Whether you are utilizing them as a values based assessment or are solely viewing them as an additional level of due diligence, there is already a strong case for including ESG considerations in investment processes and this case is growing stronger by the day.
The above article was previously published by Brooks Macdonald on 14th May 2019