Some years back I remember that I paid little attention to using sustainable funds within the portfolios that I designed. Most clients were interested in the best possible returns, although on occasions I would come across one that wanted to make sure that they invested in ‘good causes.’
While the need for us all to be more careful and consider the impact of what we do, consume and throw away is high on the world’s agenda. What’s happened to sustainable investing?
While no one was looking it’s become ESG investing, Environmental, Social and Governance to give it its full title. Now whilst I understand the need to widen the remit, I’m not sure that the new title helps to elevate this in the way that was hoped, as few understand the meaning of what each of these covers.
The following table gives an idea of what is covered by each section of ESG:
Pollution & waste
As eluded to earlier one of the biggest problems that this sector of the market is that of performance. The idea that incorporating ESG factors into the investment process will hurt performance is still commonly held.
In the past there may have been some truth in this because of the limited number of funds available but these days there is a far greater choice and given that some studies suggest that companies with robust ESG practices displayed a lower cost of capital, lower volatility, and fewer instances of bribery, corruption and fraud over certain time periods. Conversely, studies have shown that companies that performed poorly on ESG have had a higher cost of capital, higher volatility due to controversies and other incidences such as spills, labor strikes and fraud, and accounting and other governance irregularities.
It may come as a surprise that several academic and investor studies in recent years have found historically lower risk and even outperformance over the medium to long term for portfolios that integrated key ESG factors alongside rigorous financial analysis.
Growing research suggests that ESG factors have contributed to long-term financial performance. ESG factors can be used to identify better-managed companies or to flag companies with business models that are likely to face headwinds or tailwinds driven by rapidly evolving regulatory, environmental, demographic or technological trends. Institutional investors are increasingly looking to ESG factors as a way to manage these risks and to achieve long-term sustainable financial performance.
With ESG being part of our daily lives it would seem a wise move to start investing in companies that score highly in these areas as well. Fund managers always want to invest in successful companies and companies with ESG at the heart of what they do are showing how successful they can be.
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