Have these words merely become platitudes for the private sector to market themselves as ‘future-friendly’? Or are the motives genuinely seeking to better the world – allocating money where it needs to go, putting their money where their mouth is?
The term ‘Environmental, Social and Governance (ESG)’ investment has solidified into a core principle universally, not limited to equities and fixed-income but today includes alternative asset classes as well. As per the financial powerhouse, JP Morgan, the figure $22.8 trillion represents the value of assets under management (AUM) for socially responsible investing. Of particular note is the 200% growth in contrast to last decade, surging from 2016 thanks to the ESG-themed Exchange Traded Funds. These are indices, for example the “iShares ESG MSCI U.S.A. ETF” issued by Blackrock, embracing institutions compatible with the principles of ESG, thereby lowering exposure to demerit goods and socially costly consumptions such as tobacco & high carbon emissions.
In layman’s terms, through analysing this portfolio, one could deduce that aside from attaining a 9.62% total return on your monetary investment you would also contribute to the reduction of CO2 emissions by 33.36 tons. This is 5 years worth of energy for a household – an immaterial investment towards sustainability. This serves as a paradigm for the immense synergy between financial and social returns, all with the benefits of diversification lowering risk exposure. Even during COVID-19, confidence and resilience has only strengthened with the heavy emphasis on the “S” and “G” of ESG. This is demonstrated by a wide range of examples from Danone’s €250m support for ‘struggling small business partners’ to Accenture’s mandate to bring together newly unemployed people with firms having vacancies.
The Chartered Financial Analyst (CFA) Institute expounds on the following challenges faced by the prospect of using ESG as a driver for combatting the development crater:
- Lack of demand from clients/investors
- These criteria set are not material—no added value
- Lack of information/data – insufficient knowledge of how to consider this criterias on a standardised basis
- Inability to integrate ESG information in quantitative models used to uphold portfolios
One may observe these factors are intrinsically linked, stemming from lack of data/information together with lack of transparent and standardised parameters to measure ESG. After all, when looking at “G”, how does one quantify attitudes of a firm’s management towards its employees; and for “S”, how do we gauge the quality of improvements towards human capital?
On top of the technicalities, a firm in itself having a vast array of operations such as Alphabet (Parent Company of Google) – ranging from self-driving cars to eco-friendly smart thermometers – shows fluctuating performance in their commitment to ESG. The prevailing imprecision and inaccuracy of scoring various ESG funds serves as a barrier from the investor’s perspective. A prime example is the scrutiny faced by Boohoo, a UK ‘fast-fashion’ retailer whose shares spiralled downward as averments of terrible working, plausibly illegal, conditions emerged despite the ‘double-A’ rating awarded for their ESG.
“Climate Risk is Capital Risk”
Notwithstanding, Larry Fink, the chief executive of Blackrock with over $7 trillion in AUM (the world’s largest asset manager), wrote a ‘letter to CEOs’ that led to significant reverberations in the industry. He substantiated on measures such as:
- Moving from short-termism to long-term views for profit-making
- Mechanisms for transparency (Sustainability Accounting Standards Board) from reporting labour practices to an active assessment of the implications of projects across industries – for instance, are alternative meat and dairy products making a dent?
- Sustainable investment beyond the United Nations Principles for Responsible Investing framework and fiscal authorities, as described by Larry Fink himself on his conversation with Bloomberg Businessweek:
“I don’t see governments working towards these long-term objectives, climate change is not going to be fixed by a central bank, it is going to be fixed by accommodation of public and private.”
To reflect and respond to the rise in demands of ESG, firms themselves need to become proactively accountable whereby in addition to their performance reports, they ought to invest in resilient IT systems. Also, they need to impose internal metrics and frameworks to ensure they are on-track to meet their goals, doing their part to ‘save the planet’. Therefore the momentum is vigorously present as investors recognise that it is not the instrument itself but the purpose too. For example, Green bonds striving to invest toward green projects and/or supporting climate change mitigation were realised when investors asked themselves how they can be impactful while maintaining the same credit and risk of other bonds.
The key step was in special reporting and declaring the social & environmental outcomes to set the tone of transparency. The consequence is that it builds sustainable capital markets while opening up avenues for both governments and the private sector to cooperate such as Blackrock and GPIF (World’s largest pension fund) for ESG data provision for sovereign and sustainable bond indices.
“Ideas can change the world but how you transform an idea into reality is a matter of process.”
The World Bank Group
Nonetheless, within the realms of sustainable, responsible and impact investing, ESG integration has considerable elevation to cover from its $4.2 trillion base. Eurosif’s study demonstrates that exclusions dominate at $9.46 trillion. These are divestment strategies from sectors that harm the environment, hinder societal health or fall short on governance for example. It can take a range from weapons to tobacco industries, with EU countries such as Poland and the Netherlands reaching 100% and 88% exclusion in tobacco respectively. While this is advantageous as far as tackling the core issues of a sustainable future is concerned, its impact is limited since the investor base has a degree of substitutability. There is likely another investor there to fill in if you divest as the investment may be financially profitable if social costs are ignored.
No wonder then that despite institutional and individual investors in Europe committing a total of $6.24 trillion in assets towards sustainable energy – i.e. an 11,900% increase from the diminutive $52 Billion in 2013, coal is still king in the energy industry with a share of over 40% of all energy production. This is a signal that ESG integration needs to grow rapidly and overcome the limitations of ‘exclusion’ investing; pursuing a more active, possibly paternal approach in how we navigate the ESG ship in the global seas of funding and investment.
“Too big to let the planet fail” as Svetlana Klimenko from The World Bank group describes the atmosphere created by institutional investors – this was verbalised just before the COVID-19 pandemic. Now that the pandemic has acted as a catalyst in shifting views, investors have become more aware. Their sentiments have skewed towards action and mitigating risk through ESG investing as shown by JP Morgan’s poll. The year 2020 is where we are expected to hit $45 Trillion in AUM within the ESG market, with 55% being positive with regards to the prospects of ESG.
Within the horizon of ESG, in terms of the breadth of sectors and depth of the due diligence conducted by investors, both ought to grow indubitably.
Earlier this may have been a strong voice, today it appears to have become an industry-wide mantra. It resonates among governments, multilateral development banks and the largest asset managers. Now the aim is to overcome the obstacles through global cooperation and coordination so that ESG becomes more effective as an investment strategy, particular as we march towards a sustainable future.