Investing is often looked at as a greedy action, having little to do about caring for the world around us and serving those in need. However, a new and growing movement is flipping this narrative on its head, by providing investing returns while doing so in businesses that prove themselves to be good stewards of the planet and people.
ESG investing explained
For those who are looking to not only produce solid returns on their investments but also look to better the world, there is more to investing than a company’s bottom-line profit. Other factors must be examined when it comes to determining where to allocate investment capital. These include environmental and social factors, as well as the corporate governance of a potential investment. This ideology has created a new and growing movement in the investing world, known as ESG. The three main factors of ESG and all they encompass are what investors utilize to determine whether a company provides more good in the world than just its profits.
- Environmental: Includes all things climate-related and the management of natural resources
- Social: Includes anything related to employee wellbeing, product liability, and risks to humankind
- Governance: Includes executive benefits and compensation, corporate ownership, and business ethics
There are a variety of tools and resources that investors utilize in determining the impact a company has in these three areas. ESG investors then use this information to determine whether a potential investment is not only profitable, but adheres to the aforementioned ESG values and standards.
In many ways, ESG investing sits inbetween traditional investing and philanthropy. In fact, many believe that the philanthropy model is unsustainable and unlikely to bring long-term social change. ESG provides an alternative that focuses on the same social good as philanthropic endeavors while also providing individuals and institutions a return on their investment.
Organizations leading the charge
As with any other movement which attempts to overthrow traditional power structures, ESG requires the help of industry leaders to create standards and policies in this new arena. Thankfully, the ESG movement has several organizations who are doing just that, by creating tools for investors to better investigate and conduct due diligence on investment opportunities.
Organizations like B Lab, are working to create heuristics and standards for companies outside of the traditional financial model. B Lab is the nonprofit organization behind a new business standard call Certified B Corporations. “B Corps”, as they are called, are businesses that have proven to use their resources and power for good in the world. Well-known businesses such as Patagonia, Ben & Jerry’s, and Kickstarter have already obtained their status as Certified B Corporations. As part of the certification, businesses must display their positive environmental impact, be owned by employees and founders, display employee fairness and equity, and other ESG factors.
Meanwhile, Principles for Responsible Investing (PRI) is the leading proponent of responsible investment. According to the organization, “It works to understand the investment implications of environmental, social and governance (ESG) factors and to support its international network of investor signatories in incorporating these factors into their investment and ownership decisions.” The organization has provided so much value that it is now backed by the United Nations.
Even traditional financial information companies are getting in on the trend. Morningstar provides ESG research and data to its customers through a variety of tools and products, and Bloomberg provides ESG analysis in its terminal, complete with an ESG Disclosure Score, Climate Score, and more.
Does this mean lower returns?
ESG isn’t just about doing good in the world. Investors believe the tenants of ESG actually play a large role in corporate profitability, and use it as a benchmark to help determine the viability of an investment and its profit potential.
Blackrock compared returns for traditional investments and their ESG-focused counterparts. They found that ESG investments provided comparable returns to their traditional counterparts. In fact, ESG-focused investments at times produce better returns, and do so with comparable volatility and dividend yields. It is clear that investors don’t lose anything with ESG investments, and instead, are afforded comparable returns while investing in responsible corporations.
Even though ESG has been around since 2005, it has only been recently that the investing ideology has grown substantially. According to the Report on US Sustainable, Responsible and Impact Investing Trends by US SIF, client demand is driving growth in the industry. As more investors seek investments which are not only profitable, but also socially responsible, financial firms have no choice but to provide them the resources to assess companies against their values.
At the beginning of 2018, ESG investing accounted for about $12 trillion in assets under management (AUM) in the United States. Astonishingly, this represents $1 in every $4 in assets under professional management in the country.
According to the report, ESG is growing for several reasons, many of which are tied to the growth of Socially Responsible Investing (SRI) as a whole. “The past two years have seen new disclosure on the part of numerous institutional investors and asset managers on how they are implementing the Principles for Responsible Investment (PRI), a global framework for taking ESG considerations into account in investment analysis, decision making and active ownership strategies,” the report says.
The category has gained enough traction that ESG analyst is now a common role at financial firms. These financial professionals spend their time identifying ESG opportunities for investors, along with producing analysis and reports to support their recommendations.
Europe is a first mover
A report by PWC predicts that ESG investing will soon be widely accepted in the United States. However, Europe has already beaten the US to the punch when it comes to ESG investing. According to the report, “In Europe, ESG investing is already integrated into many institutional mandates and part of a favored approach for HNWIs.”
There has been talk of the European Union stepping in to regulate ESG factors for corporations, but this is an idea that leaves many feeling uneasy. Matti Leppälä, CEO of PensionsEurope (an organization that promotes employee pension funds on a national level) sees it as the responsibility of the investor, not the government to assess the corporate responsibility of a business. “There are countless different ways in which pension funds do responsible investments,” says Leppälä. “The EU should stay clear of any prescriptive one-size-fits-all approach. The number of pension funds that choose to proactively invest according to ESG criteria is growing and will continue to do so.”
The future of ESG
It is clear ESG is growing due to the commitment investors have to responsible investing, and the need for more accountability by corporations. One area which is becoming increasingly important is climate change. In fact, Principles for Responsible Investment sees climate change as the leading issue in ESG investing. Initiatives like The Investor Agenda are providing investors an outlet to help address climate change through their investments.
Because investors now demand more corporate responsibility, businesses are talking about ESG more than ever. According to a report by Blackrock, talk of ESG on corporate earnings calls has risen significantly across the board in recent years. This is especially true in industries such as consumers staples, financials, and healthcare, where ESG factors are likely to play a larger role. For instance, social responsibility is becoming more important in the healthcare industry, where companies are being asked to provide healthcare services appropriately and accurately, without focusing solely on corporate profits.
Much of ESG investing growth can be attributed to millennial investors, who are more likely to seek socially responsible investments. Over the next 30-years millennial investors will acquire more capital for investment, and as a result, could allocate between $15-$20 trillion to ESG investments in the United States alone.
Moral of the ESG story
In a world where investors can allocate capital to almost anything imaginable, more and more people are adamant about their investments aligning with their personal values. This is especially true in younger generations, who over the next several decades will acquire more capital to invest, making them powerful players in pushing for ESG-based investments.
At the same time, ESG investing gives investors a comparable return to traditional investment strategies. Because they see a similar risk profile, more investors are likely to push toward ESG investments which do more than just provide a profit. ESG investing is showing no signs of letting up, and as a result, could make the world a better place.