Kingston finance experts explain what ESG investing is - and why it matters
By Ellie Brown - Local Democracy Reporter
2nd Mar 2022 | Opinion
IN his latest blog for Kingston Nub News, local finance expert Jason Lurie explains what ESG investing is and is not - and why this matters to companies and financial planners.
Holland Hahn & Wills financial advisers Simon Ainley and Amyr Rocha-Lima also discuss this in their latest Fireside Chat video above
In recent years, Environmental, Social, Governance (ESG) investing has become an area of interest to investors and has been increasingly publicized and discussed by companies, financial planners, and investors, but what is environmental, social and governance investing?
Simon and Amyr talk about ESG in their January 2022 Fireside Chat (see video above.) However, I thought that today I would add a little more detail to the conversation.
What exactly is ESG?
In this article, we discuss what ESG is, what it is not, and the basics of ESG investing. At Holland Hahn & Wills, we have been running ESG portfolios alongside 'regular' portfolios for the past 4 years.
ESG stands for Environmental, Social, and Governance and covers both non-financial and investment criteria. However, there are challenges as companies use different terminology which confuses matters.
Terms such as environment, social and governance (ESG), socially responsible investing (SRI), green investing, impact investing and sustainable investing can all be found.
As Simon and Amyr put it, we can define ESG in a simple way as follows:
- Environmental: How a company performs as a steward of the planet
- Social: How a company manages its relationship with employees, suppliers, customers, and community
- Governance: How a company leadership manages executive pay, internal operations, and shareholder rights
What Are ESG Factors?
ESG factors are thought of as external and internal elements that may influence the sustainable long-term growth and profitability of a company.
These factors expand the investment decision process beyond traditional quantitative and qualitative analytics, adding to the process the component of longer-term, strategic thinking on the part of management.
While there is no single listing of what an ESG factor may be, there are certain data points frequently collected by research providers and published by companies themselves.
The chart above shows a short list of some ESG factors. Some factors are easier to see and identify or quantify than others.
For example, energy consumption is an essential factor to many businesses, and the cost and reliability of that energy, can play a role in a company's success.
A company can track and report its electricity use and the source of that electricity as well as its internal assessment of the risk of power disruption or changes in cost or access – examples of an "E" factor.
Some companies' operations are dependent on key components sourced from areas that are less than democratic or have weak labour laws.
Political upheaval or community conflicts could affect performance. A company can consider the likelihood of such disruptions and perhaps how to pre-empt or reduce the effect of negative situations – an "S" factor.
Having a reasonable Human Rights Policy and solid community engagement program could be used, but each situation must be evaluated on its own, qualitatively.
The governance structure and composition of a company's board of directors and executive management team is a "G" factor, which, can provide valuable insight into a company.
More corporate (and non-profit as well) boards seek to diversify their memberships both in social factors such as gender, race/ethnicity, and age, and in professional experience and background.
This boardroom diversity combined with a broader and more engaging board culture could produce better future results.
Of course, not all ESG factors have the same or equal relevance to all sectors or industries.
For example, while looking after employees and treating customers fairly is relevant to all companies, jobs that involve a major manual component and therefore a physical risk need a different approach to 'desk-jobs'.
Their health and safety record are an aspect of a company's social commitment, which affects the quality of its "S".
How Is ESG Used In Company Analysis?
Today, ESG factors are used as an added layer when analysing a company as they can provide insight into a company's culture, its time horizon, and its priorities.
Integrating these factors in investment analysis, alongside traditional techniques of analysing financial risk and return offers a more in-depth company analysis.
For example, a company's attention to cybersecurity is an increasing level of importance in our internet-based world. As another example, lower carbon emissions are of vital importance in the fight against global warming.
Therefore, a materials company with a manufacturing process that is demonstrably lower in greenhouse gas emissions may be well-placed to benefit from the situation.
What Are ESG Metrics?
It is possible to obtain "ESG scores," from several data analysing firms or rating agencies1, which is a quick quick way to evaluate a company's ESG credentials.
Of course, any ESG score is dependent upon the opinion of the data provider, both in their methodology and how they interpret the data.
This is a good starting point for investment managers that offer ESG funds. They usually back this up with a more detailed analysis of the company in question (with particular emphasis on governance, as this is relatively straightforward to consider).
What ESG Is NOT?
It is reasonable to state that ESG is not one specific investable entity or product.
It is important to remember that when a rating agency, such as Standard & Poor's or Morningstar, categorizes a product or strategy as ESG, not every factor within the category is comparable.
In fact, ESG factors can be considered in any investment strategy, any asset class, any geography, any market cap, and any investment objective.
ESG factors can also be weighted arbitrarily by an analyst, which creates very different conclusions about a company's ESG qualities. ESG today is subject to wide variation and interpretation.
ESG Versus Investment Return
Many years ago, funds known as 'green' funds appeared. These were originally a way of appealing to investors more as an appeal to conscience and they generally underperformed their market sector (often due to higher charges or less market diversification).
Nowadays this is no longer the case. There is no reason ESG should result in underperformance2 (nor does the use of ESG guarantee outperformance3).
Is ESG Investing The Same As SRI Investing?
The most common types of sustainable investing are socially responsible investing (SRI), which excludes companies based on certain criteria, and ESG, a more broad-based approach focused on protecting a portfolio from operational or reputational risk.
With SRI, investors pick stocks or funds based on a set of standards such as positive or negative screening, the level of shareholder engagement or community/impact investing.
With screening, for example, investors may eliminate a company from a portfolio if it's involved in weapons contracting, tobacco or gambling.
On the other hand, a company might be included if it has a gender-diverse board of directors, or a strong track record of reducing greenhouse gas emissions.
ESG investing considers a broader set of due diligence questions on how environmental, social and governance factors impact performance, both positively and negatively.
For instance, an oil and gas company might be considered a responsible investment if it's working continuously to reduce emissions in its operations, has a strong safety record and is giving back to the communities where it operates.
Interest In ESG Is Growing
Findings from GlobeScan's 2021 public opinion research4 show that thirty-nine percent of retail investors around the world say they have invested with ESG in mind and another 39 percent say they have considered it.
Shareholders in Asian markets (especially China, Thailand, and Vietnam) are most likely to have already bought or sold shares because of the company's social and environmental responsibility approach.
Investment based on ESG considerations has increased over the past two decades in the G7 markets, where 37 percent now say they have bought or sold shares based on ESG – up from 24 percent in 2003. Half of American retail investors (51%) now say ESG has influenced their investments, up 25 points compared to 2003.
Forty-seven percent of French investors have invested with ESG in mind (up from 28% in 2003), as well as 44 percent of Italian investors (up from 34% in 2003).
Eight in ten retail investors globally (82%) say that they are interested in investing in companies that are socially and environmentally responsible, and 72 percent want to avoid any industry that contributes to climate change.
Seventy percent of investors also agree that the more socially and environmentally responsible investments are, the higher the financial returns are for investors.
However, despite 74 percent of investors claiming to have heard a lot about ESG investment options, nearly one in three say that they lack the information required to guide and evaluate their investments in socially and environmentally responsible companies.
Compared to younger generations, Baby Boomers are less informed about investments in companies that are socially and environmentally responsible, are less likely to believe such companies could deliver higher financial returns and are less interested in investing in responsible companies than others.
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