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26 Nov 2020
An introduction to ESG Investing
Doing well by doing good
Many readers have come across the abbreviation ‘ESG’, but there is often confusion about what it is. As ESG investing gains a higher profile, it’s worthwhile explaining exactly what this term means.
What is ESG?
ESG stands for environmental, social, and governance, and the term refers to a style of investment that integrates these factors into the process and decision-making. ESG covers a wide range of risks and opportunities which historically have not been part of the traditional financial analysis but would arguably have financial relevance.
What issues come under the umbrella of ESG?
The three pillars of ESG each include a wide range of topics:
Environmental – issues that affect the planet, such as climate change, pollution, biodiversity, waste, use of natural resources including water, forestry, and mining.
Social –issues that relate to people, such as human rights, labour standards, child labour, equal opportunities and food supply.
Governance –issues relating to company management such as board structure, executive remuneration, bonuses, avoidance of bribery and corruption.
Is ESG the same as ethical investing?
ESG investing should not be confused with ethical investing, which is incorporating our moral beliefs as individuals into investment decision making. Ethical investing relates to values based on ethical concerns such as tobacco, armaments, pornography, alcohol, animal welfare, and animal testing.
Why is ESG investing gaining profile so quickly?
In 2020, the COVID-19 pandemic has highlighted the need for people and companies to act in a more responsible and sustainable way, while social justice movements (such as Black Lives Matter) have increased our awareness of societal imbalances in need of correction.
And, if not for these high profile news stories, one would imagine the headlines this year would have been dominated by stories about the record-breaking number of natural disasters happening around the globe.
- This year saw the second time that the official alphabetical list of hurricane names has been used up, meaning forecasters have had to move to the supplementary list of Greek letter names
- Wildfires have burned millions of acres across the planet
- The weather station in the Siberian town Verkhoyansk measured a maximum temperature of 38 degrees Celsius in June this year
- The polar ice caps are melting 6 times faster than in the 90s resulting in rising sea levels
How are ESG factors linked to financial performance?
Most corporate leaders understand that businesses have a key role to play in tackling urgent environmental challenges, but, in the past, many have believed that pursuing a sustainability agenda could negatively impact the company’s profitability.
That perception is outdated. ESG investing is here to stay. Even though investors have been raising their concerns about sustainability over many decades, their concerns must now be translated into actions. Investors have injected record sums into sustainable funds during the coronavirus pandemic, pushing ESG asset under management to record highs.
It should also be noted that ESG factors drivers of outperformance. These metrics have been strong indicators of future volatility, earnings risk, price declines and bankruptcies. According to research produced by Merrill Lynch, ESG could have helped investors avoid 90% of bankruptcies and an investor who only held stocks with above-average ESG score would have avoided 15 of the 17 bankruptcies we have seen since 2008.
ESG investing is not a ‘nice to have’. It is a great way of managing your portfolio whilst making a difference.