Environmental, Social and Governance investors are bang on the money
ESG investing integrates environmental, social, and governance factors into the investment process. The concept originated in the Socially Responsible Investment (SRI) movement of the 1960s, and was widely popularised by the instrumental ‘Who Cares Wins’ report of 2005. The report detailed the findings of a joint initiative by the International Finance Corporation, the UN Global Compact, and the Swiss Government to explore how ESG could merge with capital markets. The report claimed that ESG investing was better investing – for everyone.
Due in part to the report, it’s now generally accepted that ESG factors are worth consideration when deciding where and how to invest. But is it really possible to invest in good causes while generating a high return?
Reconciling profit and purpose
Historically, ‘sin stocks’ – think alcohol, gambling, tobacco – have been viewed as generating the highest returns. Not so long ago, the world of finance was decidedly colder, and saw environmental, social, and governance concerns as detrimental to performance. Admittedly, pouring capital into developing or emerging markets does come with higher risk.
The ESG movement, however, suggests that this is not the case, and that investing in line with ESG factors like diversity and data privacy generates high returns. Today, ESG investing accounts for roughly a quarter of all assets under management (AUM). Furthermore, the UN’s Principles for Responsible Investing (PRI) has accumulated around $70tr in AUM since it was founded in 2006. A study by FactorResearch, while sceptical about the integrity of ESG initiatives, confirmed that ESG factors consistently led to high returns between 2009 and 2018. It’s little wonder that financial institutions like BlackRock have been quick to expand their ESG portfolios.
From a business perspective, the most obvious benefit of ESG investing is that it makes money. Far from harming performance, ESG investments are lucrative. This is largely because purposeful and sustainable companies attract customers. A company with strong ESG values is likely to stand the test of time and weather rapidly changing markets. As such, investing in a company with strong ESG values makes sense. Aside from that, ESG investing supports companies and initiatives that aim to improve the environment, society, and governance in some way. This means more money for universally beneficial goals across a broad scale.
In theory, greater attention to ESG factors should lead to positive market development – and not just in finance. Companies want and often need investment. So, as ESG considerations become more important, businesses will actively try to exhibit good behaviour. The preference of environmentally and socially sound investing may also reduce the funds allocated to ‘sin stocks’ that have damaging consequences across the supply chain. Investors will, in a sense, invest with their feet, aligning their own personal values with their portfolios. This rings true for investment firms as well as individuals. And, even if an investment firm isn’t particularly philanthropic, it will need to accept that sustainable funding is exactly that: sustainable. ESG initiatives are built with the future in mind, and are therefore more likely to survive disruption.
Fad or fixture
Finance is, by nature, changeable… So is ESG investing just another fad? Over the past 15 years, ESG investing has grown up, and the factors that have caused this growth are here to stay. In previous years, a lack of data did little to encourage investors to risk ESG investments, but thanks to the quality and availability of data analysis techniques, it’s possible to understand its value. On the one hand, value refers to the generation of returns, but on the other, it also describes wider positive impact.
Greater public and corporate understanding of the sustainability agenda has transformed the mindset of both consumers and companies. As environmental issues like global warming and water scarcity begin to tangibly impact the planet, they can no longer be ignored. Calls for social and economic equality have also played a key role. Gradually, ESG investing is increasingly viewed as part of an investor’s duty, both to their stakeholders and to the wider world. In other words, who cares really does win.
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