“Do the right thing. It will gratify some people and astonish the rest”
- Mark Twain
In recent years, adoption of environmental, social and governance (ESG)-focussed investing has accelerated. For investors, consideration of ESG factors has gone from a nice-to-have to a need-to-have over the past decade. This is a positive development. Recent research has shown that factoring in material ESG risks during the investment process can help generate a high-quality return stream that is likely to be more stable over the long term.
Evolution of ESG
ESG investing is on the rise. According to a recent survey of institutional investors by State Street Global Advisors, 80% of institutions now incorporate an ESG component within their investment strategies, with more than two-thirds of these institutions stating that the integration of ESG has significantly improved their returns.
What is driving this trend? One reason is the growing awareness of the effects of climate change and other man-made environmental change. This is particularly true of millennial investors and women, both of whom hold an increasing share of wealth and are behind the shift to ESG investing. From the perspective of the asset management industry, there is also growing acceptance that incorporating ESG factors is a key element of investment analysis and therefore an integral aspect of investment managers' fiduciary duty to clients.
A major development in the rise of ESG investing was in September 2015, when the United Nations General Assembly adopted the 2030 agenda for Sustainable Development that includes 17 Sustainable Development Goals (SDGs). The new agenda emphasises a holistic approach to achieving sustainable development for all. As investors, it is important that we find a way to support them, and simplify them into our own understandable format within the investment research process. And that is why we have translated the UN goals into eight separate pillars of positive investment and action that we can look for in the companies that we choose to invest in. For example “Affordable and Clean Energy” and “Climate Action” fit into our “Sustainable Energy” pillar.
It has been estimated than in order to achieve the SDGs it will require between $75-$105 trillion dollars of investment. Admittedly a large responsibility lies with governments, which can effect change through means such as tax incentives and infrastructure investments. But the private sector must also step up. This requires inspiration and innovation, and idea generation supporting the efficient allocation of capital. This is where new technologies can achieve commercial success, where sunlight can be transformed into electricity and where plants can become more than simply a salad ingredient.
Investing not philanthropy
By integrating ESG considerations on a holistic, fundamental basis, investment managers can better price the asset they are investing in. This helps avoid overpaying for an investment. Understanding the individual material issues of an asset helps managers determine the most appropriate weighting for a particular asset within a portfolio. Additionally, full integration of ESG into the investment process helps investors better engage with companies on the issues that will have the most significant, long-term impact on their businesses. Finally, ESG integration helps manage the downside risk, or the risk that an asset loses value because it allows investors to focus on the long-term risks to the business.
Impact investing versus return
Impact investing is the practice of investing in companies that are selected not only for their potential for a positive return, but also for their ability to deliver measurable environmental and social impact as part of their long-term business strategy. Asset managers should use their money, resources and expertise to invest in companies that are actively seeking solutions for environmental and social issues.
A key question for investors here is can you generate strong returns and still invest for positive impact? A study conducted by the MSCI shows that the answer is yes. It has been proven that both a static tilt approach and dynamic momentum produce better risk adjusted returns, and a better return than the overall market.
As investors we believe that it is possible to act in the best interests of our planet and society while at the same time seeking to reap strong financial returns. As a business, we review our universe of global opportunities, 2,000 of which we have under continuous coverage. From this we whittle down the opportunities to around 100-150 stocks from which to build our portfolio. The final result is a portfolio of 30-60 stocks that we believe can best deliver a financial return while having a meaningful and measurable impact on society and the environment.
Investors can make a positive difference to society through the right investment choices. And crucially, this approach does not have to mean sacrificing returns.
Investors really can have their cake and eat it.