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Environmental, social and governance investing. These three components of ESG investing are used by fund managers and investors as a way of measuring a company’s sustainability and social impact on society, and whether it should be included in their portfolio as a result.
But this is a little more nuanced than some might initially suspect.
It’s not always as simple as “this company is bad for the environment so we won’t invest in it”. There are quite a number of factors in play when considering their investment worthiness.
And this is where the lines can become blurred as to which companies fit within these ESG parameters. There is no set list of companies that fall under this category; it’s almost entirely up to the fund managers or individual to determine this, but this can obviously differ wildly from person to person.
Ultimately one might use this investment approach not only to receive a return on their money, but also to support the long-term positive impact of a more sustainable and environmentally conscious world.
A quick history
Ever since the birth of the industrialised world, capitalism has dominated political thought with future profit and growth being key to how investors make decisions on where they put their money.
There have always been a number of other factors that determine where investors put their money, but considering how our investments can have a positive impact on the wider world has only been in the investment consciousness since the around the 60s.
Trade Unions in the US started to realise their huge sums of capital can have tangible and positive changes in the form of affordable housing projects and new health facilities.
The Apartheid in South Africa in the 70s also brought to the fore a growing demand for de-investment in companies that supported the regime. Codes of Conduct were starting to be formed to decide how western companies did business in South Africa, and whether investment in certain companies would further aid the racial division or go some way in making a statement against it.
The ‘responsible investor’ was beginning to become more prominent as a field of investor thought throughout the rest of the 20th Century. Then, in the late 90s, a man by the name of John Elkington coined the phrase the triple bottom line to describe the additional social and environmental considerations that would start to be a factor when thinking about a company’s value.
Moving into the early years of the 21st Century, a number of big banks and financial institutions even started to use specialist ESG research services to make decisions on investments and financial practises.
Since then, many discussions have arisen around the position of ESG investing within an investment portfolio and debates on both sides have argued that investors should expect slower and/ or smaller returns when investing in such a way. Others have argued the complete opposite, and the debate still seems to be up in the air.
Even the name itself has been debated. This field of investing is full of buzzwords like ‘eco’ and ‘green’, but a study including 350 investment professionals back in 2008, concluded the vast majority of those agreed on ‘ESG’ as the preferred name for this approach to investing.
Since then the ESG field has exploded. According to Forbes (2020), the area saw a 42% increase alone from 2018 in the US, with over $17trillion of assets being under management that apply ESG investing strategies.*
Factors associated with ESG investing
There are a number of factors investors may consider when looking to put their money towards something that will hopefully have a positive impact on the world.
There are a multitude of factors, but just so this post isn’t 1000 pages long, I’ve picked the three main areas you might consider if you’re looking at this as an option:
- Corporate governance
Businesses have an enormous impact on the environment. Whether they’re mining finite natural oils and minerals, heavily reliant on travel that pumps harmful gases into the environment, or producing tonnes of single-use items that’ll quickly end up in a landfill (or in a park if you’ve seen the recent news).
As an investor we may choose to put our money towards those companies that either directly address these issues, or who are simply attempting to reduce their negative impact in some way.
An example of the former might be a company along the lines of TRIG who own large solar farms, battery storage facilities and wind farms in order to help us move away from our reliance on fossil fuels.
An example of the latter may be the introduction of re-usable cups in coffee shops in order to reduce non-biodegradable waste.
A company’s treatment of their employees and wider distribution chain may also play a huge part in choosing whether or not to invest.
Factors such as working conditions, length of working hours without a break and reducing risk in the workplace are just some considerations that fall under this area.
Another considerable factor, but one that probably relates more to specific industries like food and cosmetics is animal welfare.
This could be the treatment of animals in testing labs or how they’re housed or whether they’re allowed to roam free.
Cosmetic companies may apply a limited or zero animal testing policy, while ‘free range’ has almost become a ubiquitous buzz-phrase throughout the produce aisles in supermarkets.
This is a fairly new factor, especially with the birth of online shopping where the consumer can’t properly see the profit before buying.
A concerted focus on offering the consumer some form of recourse in the event of unfair treatment or mis-selling of products and services.
One historically significant event that led to an increased focus in this area was the 2008 housing market crash, where the mis-selling of subprime mortgage created an almost pyramid scheme esque crash that shook the world over.
You can also see examples specific to the UK, with the introduction of the Financial Services Compensation Scheme (FSCS) in 2001 that guarantees the individual’s money in their savings account up to £85k. The bank, building society or institution you’re using though must be come under the FSCS checker list.
Corporate governance considerations
Companies are now often scrutinised for the compensation they pay out to their executive level employees.
Too high a bonus for under-performance, or too high a pay that vastly exceeds lower rung employees, is often criticised in the media and may be a reason for someone deciding whether or not to invest and support these compensation practises.
Whether or not employees are fairly compensated also fall under this category.
One might look to determine whether pay is fairly split according to position, achievement, skill and identity before investing their money.
You’ll often see annual articles on the best companies to work for, whether that’s additional benefits they offer, workspace conditions or that awful buzz-phrase ‘company culture’.
Another factor that may fall under this category might also be the employees’ ability to voice their opinion and suggest changes no matter their level. This could come in many forms, from surveys to CEO Q&As, but the most recognisable employee relations movement might be that of the Unions: groups of employees able to gather as a collective in order to enact changes for their benefit rather than the company or higher executives. Unions aren’t as prominent as they used to be in the UK, but are still very active in industries like teaching, transport and healthcare to name a few.
Despite the intended positive impact ESG investing is trying to have on the world, a number of companies and brokers are jumping on bandwagon to appear like they’re making changes, when in actual fact many may just see through the facade as it being nothing more than ‘greenwashing’.
Greenwashing is a form of PR and marketing spin, used to create the illusion of positive change, rather than actually making any real, tangible changes at all.
One example of this I’ve seen in recent years has been that of BP. I’ve seen huge social media and online campaigns dedicated to saying how they’re making positive changes in a number of ways.
But I can’t help but feel a company that removes something from the ground that forms naturally, and therefore shouldn’t belong to anyone, while spilling metric tonnes of it and polluting the environment, doesn’t really have a leg to stand on no matter what changes they’re enacting.
There are many examples of this including, Apple (working conditions), Unilever (promise to reduce plastic when that’s literally what their business model relies on) and pretty much every bank (HSBC and the Cartel scandal; Morgan Stanley, JPMorgan, Goldman Sachs and many many others who had a hand in the ’08 crash).
Fund managers are also trying this on too. ‘Eco Green-Power Sustainability Income Fund’ may sound like it’s ticking all the ESG boxes all at once, but lift the lid and you may just be paying for a tracker that hugs the index and removes a few cigarette companies just to appear like they’re trying, and charges you a fortune for the pleasure. Always try and get as much information about these funds as possible and don’t just rely on the name and top 10 holdings alone.
Is ESG the future of investing?
I’d argue anyone considering whether or not to invest in a company who at least doesn’t consider the governance side is just not doing their proper due diligence anyway. So in that sense, yes…it should always play an important factor in investment decisions even if you’re not bothered by the environmental or social impact parts.
A company without good governance is surely a bad investment no matter how you look at it.
Standardising what ESG means
At the moment there is no standard for whether a company falls into the category of ESG compliant; it’s all a matter of opinion at the moment.
To borrow a phrase from one of my favourite fields in semantic theory, the definition of what is and isn’t an ethically focused company can produce some fuzzy boundaries (when does a bowl become a plate?).
Many organisations and institutions have tried to formulate a more standardised meaning of what it means to be an ESG compliant company – such as the International Organisation for Standardisation (ISO) – but the universal acceptance of these standards is yet to be fully realised at the time of writing this post.
Also the ethical and environmental impact a company has on the world is still left to the company itself to reveal.
Unlike being able to look at a public company’s financial records and determine its financial health, it’s a lot more difficult to uncover environmental and social concerns related to that company as this is still down to the company itself to disclose. With no standardised testing for ESG compliance, bias and unreliability is sure to creep into reports, not giving the full picture.
All in all, ESG investing has come a long way in recent years and become increasingly more widely adopted and accepted when considering our next investment.
Issues around standardised compliance testing will continue to be a thorn in its side damaging the reliability of such testing, but I think only time will tell before a proper metric of quality testing for ESG focused business practises is realised.