Understanding Environmental, Social and GovernancePosted on: 12 February 2019 by Peter McGahan
Reducing risk, extra returns, and being nice with it. That’s ESG.
Following last week’s column on Environmental, Social and Governance (ESG) investing, what are the issues to look out for when screening for the best returns and best funds to choose?
In the ‘beginning’, we had ethical funds, sustainable funds and socially responsible funds, now we have the term ESG.
Ethical funds avoided anything that did harm, such as tobacco and weapons manufacturers by screening out what was ‘evil’. Sustainable investing scanned for companies that had a positive impact on the world, such as companies providing clean energy, recycling and so on.
ESG funds scan for the above two and also align with impact investing with companies, for example, who have the sole purpose of solving social or environmental problems. Investment companies also engage with the companies they invest into and use shareholder power to positively influence their corporate behaviour.
The good, the bad and the ugly
There are undoubtedly views on what constitutes ‘good’ and ‘bad’ companies to invest into, and so investors should insist their Independent Financial Advisers (IFA) study any potential investment fund’s prospectus thoroughly before investing. Most IFA’s analyse the integrity of the research, so as not to drop a client in an investment that matches on the one hand, and conflicts on the other.
Good news: The investment association is asking for input from Independent Financial Advisers before March 1st to ascertain the agreed standard of definitions, development of a UK product label, and define how reporting is offered by such companies to verify their wider impact on sustainability.
In this speedy world of convenience, in trying to assess how appropriate an investment is, we might want a metric such as the ‘10’ Bo Derek was made famous for, and if that straight forward metric doesn’t work, how about a variation of it, such as 9 or less. That way we can easily choose, right?
Nope, it doesn’t work. When you squeeze huge amounts of financial data and pump out a number, it mightn’t tell you if Miss Derek is funny, a nice person, or indeed a sociopath. A non-mathematical chat with her, and perhaps a beer, would potentially save a couple of years of stalking after a morning of embarrassment.
Qualitatively analysing a fund (looking under the bonnet at what’s really happening) will tell you a lot more when combined with the numbers.
Tesla is an example. Three highly relied-upon research companies (CLSA, MSCI and Sustainalytics) rated Tesla last, 1st and middle of the pack. Enough said.
As mentioned last week, ESG is gathering immense pace and the investors are demanding more. The above report couldn’t come quicker.
Take, for example, the Yale students insisting their endowment should be divested from Blackrock investments because other Blackrock funds were invested into private prison companies. The complexities of researching are assisted by the huge, unbeatable, tidal wave of unencumbered millennials and generation Z.
Social conscience meets investment priority
42% of investors now agree that social and environmental impact is a key part of decision making, with 67% of them placing a higher value on impact than returns, whilst weighting their decisions on their true personal values over the long term. Female investors are nearly twice as likely as male investors to focus on positive impact on the world alongside investment returns.
Are these eco warriors biting their nose off to spite their face with investment returns?
Those companies whose ESG credentials have been improving have outperformed in emerging markets by 14.4%, and 5.2% in developed markets over five years. It’s hard to see this trend reversing.
The research by MSCI also showed that a company rated upward on its ESG profile led to higher valuations in the market (and vice versa) and that its upward rating isn’t explainable “by the general market or other factors”.
A Hermes study also noted there was no evidence of a company investing into environmental areas having any underperformance.
Studies also show that ESG investing has reduced volatility inside investment portfolios. It all makes sense.
If a company ticks the E, S and G boxes, it’s doing the right things, and will attract the right investors, customers and staff, and that will boost the bottom line.
Imagine if they screened countries!
About the author
Peter McGahan is Chief Executive of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
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