As the tide in morally responsible ESG investing shows no sign of slowing, and accusations of greenwashing fly around like facemasks on 2020 streets – we look into how, or if, the investment industry is truly moving the dial towards contributing to a more sustainable world.
Why has ESG investing become so popular?
As explained in our Green Finance intro, ESG or morally responsible investing, looks to make a financial return whilst taking Environmental, Social and Governance factors into account. Hence, ESG investing.
The rationale is that by taking a stake, and supporting, an organisation which is operating in a ‘responsible’ or ‘sustainable’ way, there will be long-term positive impacts for society and the environment.
This type of investment is really gaining momentum. The US Forum for Sustainable and Responsible Investment found that around $17 trillion dollars, one in every three being invested in the US, is now claiming to have a focus on the ESG sector.
Historically passed off for hippies and activists, sustainable investing was the cause of eye-rolls in board rooms all over financial centres, merely the side dish to accompany a main course of shareholdings in fossil fuels, tobacco and gambling industries.
But then the tides started to turn. As clients attuned to more postmodern values, so did the investment managers. Morally responsible ESG investing has gained momentum due to a number of factors, including:
- Longer term analysis was possible and the data showed that well-managed companies, exposed to fewer structural and governance-based risks, were providing returns to rival the more traditional growth or value investment strategies. Like tofu and reusable coffee cups – responsible investing was no longer just for the nonconformists.
- Investors began to ask challenging questions – voting with their (divesting) feet when the answers weren’t shifting far enough along the colour spectrum to green. That shift couldn’t be heard clearer than by Oil & Gas giant ExxonMobil, who were removed from the Dow Jones index back in August, having been a member since the 1920s! They are now being surpassed by businesses focussing on the future, not the past.
But wait, how does ESG investing actually help our planet?
To put it simply, the two deciding measures for most investments are Risk and Return:.
Risk – what risks they are exposed to which could jeopardise that likelihood.
Return what the anticipated financial return of an investment could be and what risks they are exposed to which could jeopardise that likelihood.
ESG investing identifies existing or emerging risks within the more specific buckets explained below:
- ‘Environmental’ – e.g. are they using renewable energies, or making a commitment to reduce their carbon footprint? Are they contributing to a shift in consumer behaviour – encouraging their customers to do the same? Are they signed up to industry commitments in sustainability?
- ‘Social’ – e.g. is their business contributing to societal issues? (So-called ‘sin’ stocks like gambling, tobacco, and increasingly, plastic and sugar.) Are they paying fair wages, and supporting their employees’ wellbeing? Are they making positive contributions to the community around them and treating their customers fairly?
- ‘Governance’ – e.g. how diverse is the representation on their boards? Do they have separation of power between chairperson and CEO? Is their executive compensation reasonable or have claims been raised around the ethics of their decision-making?
So, if an investment manager includes ESG factors within their investment decision-making process, they will hopefully only be backing companies which have a moral compass. The long term return on the investment is increased, and the risk is reduced.
And what happens if you don’t behave in a morally ‘good’ way as a business? You only have to look at the BooHoo share price history from this year to understand how conducting business in an unethical way can hurt more than just your reputation).
So happy days then yeah?
Not quite….Whilst investment bodies and regulators are still forming the rules to the responsible investing game, many investment managers have been quick to maximise on this opacity and rebrand their existing strategies as ‘conscious’, ‘ethical’ and ‘clean’ (without necessarily making fundamental changes according to ESG best-practice – a common example of ‘greenwashing’.
What is financial greenwashing?
Much like the oil industry’s recent slew of green advertising, there inevitably came a bandwagon to jump upon within the investment sector. As defined by global asset manager, Schroders, greenwashing is ‘falsely communicating the environmental benefits of a product or service in order to make an entity seem more environmentally-friendly than it really is.’ And with Nine out of Ten companies listed on the US S&P500 now producing sustainability reports – how are corporate and individual investors alike, able to separate the ethical from the mythical?
Sounds like we need some better regulation….
And that is coming soon….The EU regulation on Sustainability-Related Disclosures will take effect in March 2021. It aims to enhance the transparency regarding integration of ESG matters, whetting the appetite for something similar in the US – with Biden’s inauguration being seen as the biodegradable glitter in the mud for the sector’s future.
The aim of these central bodies is to start being able to assess whether an investment manager is merely excluding the bad stuff, or actively pushing for the good? And how does it work?
- Active Management – Shareholders are given voting rights, which can be used to influence and shape an organisation by approving, or rejecting certain strategies the board proposes..
- Stewardship – large shareholders can then use their position to further engage with the directors on areas of concern, to manage them from ‘within’.
It’s the investment firms which place resource and effort into both these areas which will prevail as gold-standard when the ESG medals are given out.
Whilst there’s still a huge amount of progress to decipher where both the environmental value-add of responsible investing could be – the future for ESG investing is certain. The current wash of sage will inevitably deepen to emerald. Yet, it is worth remembering that even ‘ESG fund managers are capitalists. They are investing to make money — they might do some good, but that good does have to lead to return’ (Michael Martin of Seven Investment Management).
Curious to learn more? We’ll explore the roles of Active Management and Stewardship further in our next financial piece! As both are pivotal in the promotion of a more sustainable investment universe.
- If you’re a shareholder, attend your company’s Annual General Meetings (AGMs) and exercise your voting rights! Or, if the company you work for is publicly listed, attend and challenge senior management from within!
- If not, you can follow the suggestions we outline in our guide to Green Finance to make your money positively impact our planet!
- Keep your eyes open for our growing Sustainable Finance content to learn more around Impact Investing, Active Ownership and Stewardship.
- Attend webinars from the United Nations Principles for Responsible Investment, to hear directly from a core body within the ESG movement.
- Listen to the Sustainable Finance Podcast where guests share how their participation in sustainable finance is disrupting “business as usual” in the investment industry.