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ESG Investing: The what, the when, and the why
Investment professionals have realised that there is increasing demand from clients for the ability to make what Deutsche Bank Wealth Management calls “a statement of ambition for the world as it should be”.
10 December, 2020

Environmental, Social, and Governance investing, colloquially referred to as ESG investing, is an approach that incorporates analyses of three vital areas of the impact of investment capital. The environmental aspect can include considerations of carbon emissions, water and air pollution, and deforestation, often leading investors to lean away from oil and gas companies. The social aspect is even broader – how a company treats its employees and handles labour disputes, public opinion about the products they manufacture and sell, and the exposure of their supply chain to interruptions caused by geopolitical events all fall under the “S” category. Lastly, governance is all about decision making, especially the make-up, conduct, values, transparency, and accountability of executive management and boards of directors in corporations. This can include anything from the gender and racial diversity of the top leadership, to the ability of management to maintain corporate resilience or ensure cyber security.

The principles behind ESG investing are not new. In the 1700s and 1800s, religious groups like the Quakers and Methodists began to develop guidelines for ethical investing for their followers. For example, the 1758 Quaker Philadelphia Yearly Meeting made it an act of misconduct to participate or invest in any business dealings involving slavery and the sale of human beings. In 1982 John Streur, the CEO of Calvert Research and Management, launched the first mutual fund with the specific aim of avoiding business supporting South Africa’s apartheid government. However, the current trend and widespread adoption of ESG consideration is a 21st century development. In 2004, then-UN Secretary General Kofi Annan invited major financial institutions to join an initiative to find ways to incorporate environmental, social, and governance concerns into investment management. A year later, the term “ESG investing” was initially coined in the “Who Cares Wins” report produced by the initiative, developed in collaboration with 20 leading global financial institutions, including Morgan Stanley, BNP Paribas, HSBC, Banco de Brasil, and the World Bank. In 2006, the UN debuted their 6 Principles for Responsible Investment (UNPRI), and the PRI is now an independent proponent of responsible investment with 7,000 corporate signatories.

ESG funds, including exchange-traded funds (ETFs), are a popular way for individual and institutional passive investors to integrate ESG into their portfolios. The First Trust ISE Global Wind Energy Index Fund, and the iShares MSCI Denmark ETF, have both delivered amazing 1 year returns of over 35%. Vanguard, Invesco, JP Morgan, and BlackRock all also offer ESG ETFs. Factoring ESG considerations into active investment management has also become more and more popular over the last 15 years. Many portfolio managers use a mixture of quantitative and qualitative information on environmental, social, and governance factors to make decisions about whether or not to invest in a company – sometimes on a case by case basis, but increasingly using this information to generate a score or rating system with minimum or maximum requirements. Earlier this year, JP Morgan Asset Management announced that their ten point ESG scoring system, which in July applied to 90% ($1.7 trillion) of client assets under management, was going to be implemented across all JPAM investment vehicles. AXA Investment Managers also use a ten point corporate scoring methodology developed by their responsible investing (RI) team, covering over 7,200 companies and 100 countries.

Today, every significant asset management firm you can think of has a page on their website about their ESG strategy and offerings. Investment professionals have realised that there is increasing demand from clients for the ability to make what Deutsche Bank Wealth Management calls “a statement of ambition for the world as it should be”. Marisa Drew, the CEO of Impact Advisory and Finance at Credit Suisse, says there is now a  “fundamental belief…that investment capital can truly perform a dual function- so generate healthy returns… without sacrifice- while also achieving a second objective, which is promoting positive change”. It is not an unreasonable assumption that this “change in belief” has been driven by data. Research has shown that the relationship between ESG criteria and corporate financial performance is one of positive correlation. A study done in 2015 by DWS Director and Senior Fund Manager Gunnar Friede showed that in 62.6% of almost 2000 cases analysed, ESG integration had a positive effect on equity returns. Research from Chicago-based investment research firm Morningstar shows that the majority of ESG funds outperform non-ESG funds over one, three, five, and ten year periods. In the twelve-month period prior to the 11th November 2020, the S&P 500 ESG Index has outperformed the S&P 500 by 2.4%.

The health crisis faced by the entire international community this year has been a strong reminder that the issues human beings (and therefore the global economy) face can no longer be solved by individual governments and political leadership alone. The business and financial world has been forced to step in to help fight the virus because simply put, COVID 19 is absolutely terrible for consumer demand, for workers, for supply chains, and for markets and investor sentiment. In September 2020, Scott Kalb, the founder and director of the Responsible Asset Allocator Initiative at the public policy think tank New America released a report detailing their findings about how leading sovereign wealth and public pension funds are adapting and increasing their use of ESG investment strategies in response to the global COVID 19 crisis. The report found that a third of the 25 leading funds they tracked have chosen to pursue impact investments into COVID-19 solutions and into supporting businesses negatively impacted by the crisis. COVID-19 has spurred investors to look into the social element of ESG in particular as they recognise how essential it is to support collective social well-being in order to maintain a strong financial system. ESG investing is here to stay, and will only become increasingly widespread and institutionalised in upcoming years. It is one of the fastest growing areas of investment management, and whether you are (or aim to be) an investment professional, a decision maker at a corporation, or really anyone in the financial or business world, you should be paying attention.

2 Comments

  1. Mandeya

    Great article Ayanda. Certainly an eye-opener for me in terms of new focus areas for corporates. This is a spin-off from what was referred to as the “triple bottom line” when I was still in corporate; profit, people and planet.

    I, being a procurement professional, would imagine ESG to be one of the selection criteria for procurement departments in the selection of suppliers for goods and services in any progressive and responsible organization.

    Keep publishing your articles. Good work.

    Reply
    • Ayanda Tambo

      Thank you for your feedback! Interesting to hear about the “three Ps”- further proof that this is in no way a new idea but rather the latest stage in the journey of how businesses and firms learn to incorporate values and non monetary factors into their work.

      Reply

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