ENVIRONMENTAL, Social and Governance (ESG) refers to a form of sustainable investing which focuses on not just the financial returns, but its overall impact. ESG investing entails examining financial data, along with factors that relate to environmental, social and governance issues.
The environmental component requires research into the ways in which a company’s operations impact the Earth both positively and negatively and may include an examination of the level of greenhouse gas emissions, recycling and waste disposal policies. The social element evaluates companies on the ways they improve their social impact both within the company and in the broader community. Factors such as gender and racial equality in hiring practices and the priority of human rights in the countries where business is done are considered. Governance addresses the company’s leadership and oversight as well as how well the leadership responds and interacts with shareholders. Some factors that are considered include how diverse is the board of directors and management team and whether the Chairman and Chief Executive Officer roles are separate.
ESG Investing Trends
As ESG criteria gains increased prominence in investing decisions, several key trends are emerging. The coronavirus pandemic in particular has intensified discussions about the interconnectedness of sustainability and the financial system. The election of US President Joe Biden has also elevated the ESG agenda. The core of President Biden’s “Build Back Better” proposal is a US$2 trillion sustainable infrastructure and clean energy plan that aims to achieve a carbon pollution–free power sector by 2035, to produce net zero emissions by 2050 and to reduce by half the carbon footprint of buildings. President Biden’s platform also includes significant social measures to reform taxation, expand healthcare coverage and provide relief for student loans.
These ESG related policies have the potential to shift the way in which business is conducted as well as benefit those firms and industries that promote a sustainable and energy efficient way of doing business. The policies are also anticipated to impact many sectors which include renewables, autos, transportation, technology, oil and gas, mining and steel, utilities, telecom and consumer goods. Additionally, the returns of major US ESG Exchange Traded Funds have trended upwards over the last four years and have even outperformed the S&P 500 during 2020. While the S&P increased by 16 per cent in 2020 ESG related funds increased by 21 per cent during the same period.
Europe continues to be a leader in the ESG investing arena. The European Fund and Asset Management Association (EFAMA) has indicated that as much as 45 per cent of total assets under management in Europe utilise some sort of ESG selection strategy. This figure is anticipated to increase in the coming years.
Major institutions such as the Chartered Financial Analyst (CFA) Institute are developing ESG disclosure standards for investment products that aim to build a framework for investment managers to better communicate to their clients and for them to better understand the nature and characteristics of ESG centric funds and investment strategies. The Sustainability Accounting Standards Board (SASB), and the Task Force on Climate Related Financial Disclosures (TCFD) are also working to form standards and define materiality to facilitate incorporation of these factors into the investment process.
The ESG space was already gaining popularity ahead of Covid-19, but the pandemic has sparked even more interest in this area. ESG investing is anticipated to provide significant rewards for investors who choose to embrace the trend of socially responsible investing and use the investment process to reflect these values and beliefs. Investing in companies that lead in environmental, social and governance best practices is no longer a niche. It is one of the strongest ways to help ensure long-term sustainable returns and should now form a significant part of investment portfolios going forward.