Brendan Bradley

Article / Updated 06-10-2021

The term “ESG investing” is often used interchangeably with sustainability or impact investing, but it isn’t a stand-alone investment strategy that provides positive impact. ESG (which stands for environmental, social, and governance) is a framework that uses a rules-based approach to evaluate companies based on their commitment to positive ESG factors and has become a fundamental part of investment analysis. Investors are increasingly applying these non-financial but material factors to identify and mitigate ESG-related risks. Therefore, ESG integration is consistent with a manager’s fiduciary duty and investment due diligence processes to consider all relevant information, beyond traditional financial metrics, in order to better understand their ESG-related risks. The ESG framework is critical in supporting the shift into mainstream ESG investing, while also being a foundation for more specific socially responsible investments (SRIs) and direct impact investments. Impact investing is more about the type of investments that a manager is targeting, while ESG factors are part of an investment assessment process. Also, impact investing is seeking to make a measurable, positive, environmental/social effect with the investments a fund manager purchases, whereas ESG is a “means to an end,” serving to identify non-financial risks that may have a material impact on an asset’s value. Therefore, while there is no direct sustainability impact from ESG, the adoption of the principles has continued to evolve, and some specific trends have emerged that are key elements in evaluating a company’s position on the virtual sustainability road map: Currently, climate change and the move toward net-zero greenhouse gas (GHG) emissions by 2050 have dominated the agenda for the Environmental aspects. Meanwhile, the coronavirus pandemic has increased consultation around the interconnection between sustainability and the financial system, with particular emphasis on the Social aspects, highlighting which companies are fully engaged with their employees and community, while championing diversity and inclusion. Last but not least, a similar light has shone more brightly on the Governance aspects, particularly board composition, executive compensation, and a willingness to engage in the sustainability reporting process. Be wary of the potential for “greenwashing,” in which ESG investment products are sold as some form of solution to the world’s ills or a quasi-charity donation that produces a sustainable impact while providing the investor with a return. While achieving a good ESG score is a positive indication that a company has a sustainable approach to management, that doesn’t in itself suggest that they will achieve a sustainable impact. Which sustainability goals should be followed? The United Nations Sustainable Development Goals (SDGs), which are aimed at ending poverty, protecting the planet, and ensuring that all people enjoy peace and prosperity, can be seen as a stimulus behind the renewed focus on sustainable investing. The COVID-19 pandemic of 2020 was a stark reminder that the world isn’t on track to achieve those goals as we head into the final decade before the deadline, and so world leaders must increase their efforts. However, everyone needs to pull their weight, and who better than business to lead the charge with their know-how, technology, and financial resources? The target is several life-changing “zeros,” with the primary focus of responsible investors currently converging on having zero emissions and ending discrimination with respect to color and gender. It’s important to remember that these goals are integrated and that action in one area will affect outcomes in others, which should balance social, economic, and environmental sustainability. The SDGs are targeted to be met by 2030, while more specific targets under the Paris Agreement, such as net-zero emissions, are due to be met by 2050, with some countries pushing more aggressively for earlier target achievement. Major developments in 2020 with respect to emissions targets included the Democratic election in the United States, with President Joe Biden being receptive to the U.S. remaining among the Paris Agreement signatories. In addition, China’s President Xi Jinping pledged to peak greenhouse gas emissions by 2030 and reach net-zero emissions by 2060. As China is currently a major polluting nation, this is a further positive step toward mitigating climate change. What’s the future of ESG investing? A survey by PwC (that’s PricewaterhouseCoopers) predicted that the share of European assets in ESG-related investments is likely to almost quadruple from 15 percent to 57 percent by 2025. Also, more than three-quarters of investors surveyed, including pension funds and insurance companies, suggested they wouldn’t buy traditional funds but rather would focus on ESG products by 2022. Investing in ESG seems to be focused on future-proofing returns but also companies protecting their reputation. Moreover, COVID-19 has added further momentum to the trend, with companies and investors recognizing the need to embrace ESG as the norm rather than the exception. However, there is still a lack of agreement on the material ESG issues that are impacting firms, a lack of uniformity in the regional approaches to ESG, and a lack of standardization of key ESG ratings and data points. Meanwhile, associated with this is the plethora of disclosure and reporting requirements to consider (see the previous section), along with further mandated regulation on the horizon. Furthermore, there are emerging trends around stewardship, with varying degrees of engagement and voting participation undertaken by different asset owners and managers. Of course, in the background are fundamental concerns around environmental, social, and governance issues that face governments of the day. Europe seems to be leading the way, with the European Commission pursuing a major green recovery package that seems to be focused on the rebuilding of coronavirus-affected economies to tackle the even greater threat of global warming. Meanwhile, the new administration in the United States is making positive noises, and China has pledged to target net-zero emissions by 2060. In short, there is plenty of stimulus to further fuel the ESG fires that have contributed toward greater enthusiasm from investors toward socially responsible investment under an ESG framework. Perhaps the further development of Machine Learning (ML) and artificial intelligence will enable enhanced analysis of ESG data; however, the old phrase “garbage in, garbage out” should be remembered if the data isn’t verified through appropriate disclosure and reporting standards. The year 2020 also saw consolidation in the ESG ratings space and greater collaboration among the reporting standard-setters, with new actors adding further input to the discussion. You won’t be short of material to satiate your appetite for sustainability! Whichever direction the market takes, ESG will be the focal point for sustainable investing for at least the next ten years, to the point where universal acceptance will negate the need to say “ESG investing” anymore, as it will be the norm.

Article / Updated 06-10-2021

The term coronavirus, along with associated words and phrases, invaded our language in 2020, and it’s quickly become a route to brand self-awareness and questionable attempts at corporate caring, with many companies jumping on the new bandwagon. The very companies that have been called out as polluters, tax dodgers, and persistent outsourcers are now urging us to #StaySafe. All companies, sincerely or not, have their corporate communications teams working on their new image as a public-spirited entity that has stepped up to help others during the pandemic, while trying to ensure that their profits aren’t further impacted than they have been already. Those with short memories perhaps forget that these are some of the same companies that have contributed to and benefited from unsustainable use of natural resources, weaker public services, and the reduced standards of living that the pandemic has unfortunately highlighted. Coronawashing on the corporate side And so, “coronawashing” has started! As Winston Churchill was famously quoted as saying, “Never let a good crisis go to waste!” The PR machine is in overdrive, with companies highlighting how they are helping to fight the crisis while ensuring that they can’t be blamed for worsening it! Social media streams are catching every soundbite and any camera footage that can possibly be used to position their company in the soft lighting of good corporate citizenship. Meanwhile, behind the scenes, the same companies are requesting government bailouts and leveraging the crisis to push for favorable legislation and reductions in regulations that are sometimes more necessary now than they were before. There has been an influx of consumer goods that are feeding off the fear of coronavirus, which highlights the stark reality that there’s no safer time for capitalism to excel than during a global pandemic! However, while COVID-19 has propelled these issues, and the ESG pillars on which they stand, to the front of our collective thinking, sustainability is still establishing itself as a core business strategy, and many of the Key Performance Indicators (such as emissions, ocean plastics, water scarcity, and social engagement) are still pointing in the wrong direction. Prior to COVID-19, the potential consequences of these issues still seemed too obscure for many companies to grasp. Some saw endorsing sustainability best practices as a “nice-to-have” rather than a vital element in their competitiveness and future success. Many organizations were still looking to maximize shareholder value in the short term, without thinking of their long-term corporate health and ongoing shift to “stakeholder capitalism.” And they are likely to be the firms that get caught out by "coronawashing" as they pay “lip service” to a short-term opportunity that should highlight their failings. Coronawashing on the investor side Company ESG objectives are one side of this story, but ESG investing will witness some of the outcomes. Skeptics had predicted that the booming investor appetite for ESG would wane when times got tough, while staunch supporters maintained that ethical and sustainable companies would prove more resilient. Thus far, evidence suggests that the supporters have been proven correct as green bonds and ESG share indexes have outperformed benchmarks. However, some of these facts may implicitly be victims of “coronawashing,” as most ESG-focused exchange-traded funds (ETFs), which have seen the lion’s share of investor flows, are by their nature passive instruments that are heavily weighted toward companies that have proved resilient in the pandemic, such as pharmaceutical and technology companies. Indeed, given that a number of ETFs are based on indexes that use exclusion rules, to deliberately exclude companies failing ESG principles that have generally exhibited poor performance of late, they have indirectly dodged underperformance! But investors need to observe closely what they are buying, as ESG scores within different indices are subjective, and not all indices are created with the same objective. Sometimes, ESG ETFs include shares that explicitly contradict how they are sold to investors. This is typically because the fund has been primarily designed to closely track the broad market, rather than be “fossil-free,” and is designed for investors looking to integrate ESG factors into their core investments without drifting too far from the overall profile of their benchmark index. While ESG investing has become even more popular, and rightly so where funds are invested in firms that are expected to be more resilient to change in the long term, there is a caveat emptor (“buyer beware”). Ultimately, it’s difficult to know how the current COVID-19 crisis will play out or what effect it will have on sustainable issues. The current warm glow of bonding against the common enemies to ESG pillars suggests positive change for the future, but others propose that governments and organizations are focused on fighting the economic slowdown and will be diverted away from sustainable projects in the near future. Consequently, some of the support offered by asset managers and “talking heads” for ESG as a “safe haven” investment now verges on coronawashing, and appropriate risk management should be observed! Furthermore, the “build back better” mantra post-pandemic needs to be considered carefully for all stakeholders. There is a view that this is a once-in-a-lifetime opportunity to reshape economies globally to be more environmentally sustainable and socially inclusive. However, the economic strain post-pandemic may cause a narrower focus on just getting the economy back on track, regardless of the environmental consequences that this may entail in the short term. It’s certainly a difficult balancing act, but the once-in-a-lifetime approach requires a global unity that may not be forthcoming.