As a signatory to the UNPRI principles, we thought it would be great to take stock of the remarkable raise of environmental, social and governance (ESG) issues in finance. According to the Global Sustainable Investment Alliance (GSIA), trends report, it highlights that global assets invested in sustainable strategies have increased by an impressive 25% to USD22.9trn between 2014 and 2016.
With ESG strategies firmly in the mainstream, we are excited to be part of the UNPRI mission in advancing the integration and stewardship of environmental, social and corporate governance (ESG) issues to investment practices. Today, asset managers continue offering the promise of favourable returns but with the enhanced integration of ESG criteria – as a performance enhancing strategy.
“Global assets invested in sustainable strategies have increased by an impressive 25% to USD22.9trn between 2014 and 2016.”
The term ESG is generally understood as the integration of environmental, social and governance criteria in the investment process which is often part of a range of other sustainable investment strategies. Such as exclusionary approaches by removing companies in controversial industries, thematic and impact investing, to name a few. Incorporating ESG covers a whole range of issues which traditionally were not part of financial analysis (see table 1). But, with the advances in technology and a greater concern around sustainable development issues the use of ESG scores presents a new tool in the sustainable investing tool box. This tool is aimed at bridging the gap between a business’s performance and ability to navigate a range of complicated questions from climate change to rising cyber dependency. The E, S, and G criteria are aggregated by ESG data providers to produce an overall ESG score which are marked relative to their own peers.
The origins of what we now call ESG investing builds on from the social responsibility investment (SRI) movements that were partly a response to the many heated political movements of the 1960’s and 1970’s. With SRI grounded on more ethical principles by effectively excluding controversial industries or “sin-stocks”, ESG is about the material risks associated with a company’s potential earnings. Thus, helping fund managers minimise downside risk and more importantly pick businesses that hope to generate value in the long run. The growing research on ESG investing are finding links with asset performance. Companies that can better navigate sustainability risks and opportunities tend to have higher valuations, solid cash flows and lower borrowing costs. Furthermore, using U.S companies, a study by Harvard Business School (Corporate Sustainability: First Evidence on Materiality) suggests that companies with stronger track records on key sustainability metrics significantly outperform companies with lower track records.
However, it is important to also approach ESG integration with a degree of scepticism as some investment professionals still struggle to understand the business case for responsible investing. Another ongoing debate revolves around separating the asset managers that are truly integrating ESG factors to those greenwashing their portfolios.
Two areas that Korkia believe are important to take note, is to understand the varying degrees of ESG integration and strategic approaches adopted by asset managers. While there are still inconsistencies in what ESG-relevant information companies report along with the endless methodologies in calculating ESG in financial valuations, we think that areas of governance and seniority involvement best reflect an asset managers commitment to ESG. The size of an asset manager’s ESG team, its ability to overcome ESG data deficiencies and the use of a range of ESG analytics (external and internal) should be the expected norm for asset managers factoring in sustainability issues. But in addition, it is important that the success of enhanced ESG information involves:
1. Strong senior management commitment
Seeing the direct link of senior management engagement with the head of an ESG or responsible investment team shows that there is a firm level commitment to ESG strategies at a board level.
2. A collaborative effort between ESG specialists and portfolio managers
It is important that engagement efforts with investee companies is done through a collaborative effort as this increases the credibility of an asset managers stewardship and advocacy efforts towards understanding the complexity of financial materiality issues.
3. Cooperation with academia and advocacy organisations
And finally, in relation to the second point, the asset manager ability to actively work on ESG issues by expanding its collaborative strategies with external stakeholders in academia and larger advocacy organisations only strengthens its legitimacy to ESG strategies.
Today, as we continue to understand the impressive range of investment approaches geared towards meeting responsible investment goals, the ESG criteria is just one of many strategies that can enhance investors ability to understand sustainable business models that can positively impact the natural environment and wellbeing of societies now and in the future. The acceleration of ESG has been impressive. And this is probably only going to intensify, considering the physical risks of more frequent extreme weather events, the increasing need for more diversity in company board rooms, the rise of data privacy scandals and the broader policy impacts on curbing emissions. As we continue to develop our own responsible investment framework, we feel nothing but excitement in supporting the continuing development of responsible investing that will act as a force for good on a truly massive scale.
Gerald Esono is supporting Korkia’s asset management team with a focus on environmental, social and governance (ESG) issues. In his free time Gerald enjoys bouldering, futsal and the challenge of learning Finnish, the language of the 6th country he can now call home.
- Hoepner et al (2016), “ESG Shareholder Engagement and Downside Risk”
- Riedl, Arno, and Paul Smeets. 2015. “Why Do Investors Hold Socially Responsible Mutual Funds?” SSRN Working Paper Series. doi:10.2139/ssrn.2354905.
- Social and Governance Issues in Investing, CFA Institute, 2015