ESG Investing Guide: Advancing ESG strategy

Marta Zadravec

Venture capital firms have historically been the first investors in many of the world’s largest and most influential companies. You have been hearing more and more about ESG investing. Research is increasingly showing that this investing method can reduce portfolio risk, generate competitive investment returns, and help investors feel good about the stocks they own. That said, it’s not a surprise that ESG investing is gaining more traction.

ESG investments are growing rapidly, comprising about 25 per cent of all funds under professional management, according to various estimates. At the same time, there are people who believe that you cannot make money through sustainability, social justice, and ESG investments. That said, it is time to establish some ESG standards for investors. The goal of ESG investing is to provide suitable returns and benefit the greater good. One of the ways it does this is by minimizing risk.

ESG portfolios not only have outperformed traditional financial assets this year but also a data analysis prepared by Morningstar concluded that almost 60 per cent of sustainable investments delivered higher returns than comparable funds over the past decade.

ESG investing has often been defined, not so much by globally accepted and agreed definitions and standards. Furthermore, several terms come into play for ESG investments. That includes: sustainable investing, impact investing, socially responsible investing, and more. Many investors think they can “do good” by investing with one of these objectives in mind.

While that may be true, industry experts have come to the conclusion that ESG investing needs standards. ESG reporting and data may help align what managers say they are doing with ESG outcomes.

How ESG investing is different

ESG is most like SRI in that it focuses on investing in publicly traded companies. However, ESG investors actively opt in to companies because of the impressive environmental, social, and governance attributes they’ve demonstrated. Sometimes, ESG homes in on companies’ material issues, which depend on their industry. For ESG investors, charitable giving is not usually a financially material aspect to consider. But climate change, along with its causes and effects, is a financially material issue, as global warming will substantially impact every company everywhere.

The ESG investment movement has every reason to be optimistic in the short term. There is growing investor and stakeholder momentum for the goals of expanded disclosure, improved corporate governance, and measurable plans and impacts, especially for climate change.

When rationalizing ESG investing with the greater SRI industry, it’s important to remember that ESG is also a stakeholder-centric theory, which argues how companies treat all their stakeholders will impact their long-term success or failure. Moving ahead, ESG investing has experienced a great deal of traction within the financial world.

ESG returns

According to Morningstar, investors can build global portfolios tilted toward high-scoring ESG companies without compromising return.

Companies with low levels of gender, racial, and other forms of diversity across workforces, management teams, and boardrooms lose out on intellectual capital and valuable perspectives.

On the other hand, companies that excel at engaging their employees to achieve per-share earnings growth more than four times higher than rivals, according to Gallup. Compared with the companies in the bottom quartile, those in the top quartile when it comes to engagement generate higher customer engagement, higher productivity, better retention, fewer accidents, and 21% higher profitability.

Plenty of data backs up the notion that high-ESG companies are also well-run, ultimately producing financial results comparable to or superior to their low-ESG peers.

Ethical investing has come a long way since SRI was a small niche in the investing universe.

Millenials adapting ESG

According to US SIF’s 2018 Report on Sustainable, Responsible, and Impact Investing Trends, total SRI assets jumped 38% to $12 trillion since 2016 in the U.S. alone. A frequently cited reason is that millennials consistently show a tendency to crave social responsibility, whether it’s in the products they purchase, the organizations they work for, or their investment portfolios.

Millennials are a massive generation, comprised of at least 71 million individuals who were born between 1981 and 1996 in America alone. Millennials represent $600 billion in annual spending in the U.S., a figure expected to grow to $1.4 trillion annually by 2020, according to Accenture.

Most millennials have yet to weather a major economic downturn before and so their investment strategy remains untested. In the event that we see a recession, ESG-related sectors could take a significant hit – especially if younger investors bail on their ESG investment theses under pressure.