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  • Writer's pictureSam Parker

ESG Investing

by Sam Parker on 05/09/22

Image source: Wix media


Introduction:

Environmental, social and governance (ESG) criteria are a set of standards used by ethical investors to screen potential investments. This criteria is becoming increasingly prevalent in the global economy as investors are more aware and willing to act upon societal concerns pertaining to the environment, organisational management, and social impacts of their investments. Thanks to ESG, the environment is better safeguarded and business operations are mutually beneficial for stakeholders and shareholders.



What are the ESG criteria?

  • Environmental criteria considers how well a company safeguards the environment. Before investing, one should ask themselves questions like “How large is this company’s carbon footprint and can this be reduced?” and “ Does the corporate policy address climate change?’’.

  • Social criteria considers everyone that holds a stake in a company. This includes a company’s employees, suppliers, end users and the communities where operations take place. Things like fair wages, treatment of workers down the supply chain, the degree consumers and communities are enriched should all be considered.

  • Governance criteria is to do with the leadership of a company. A company with a high ESG score may have high diversity and inclusivity, reasonable executive pay, low corruption and corporate transparency.


Should I use ESG to invest?

Although investing in ESG’s may sound like the way to go for the future of our global economy and the betterment of our environment, it is a decision that many are reluctant to make. Unfortunately, ESG oriented investors may not enjoy as extraordinary returns as traditional investors. A 2019 study by Rocco Ciciretti, Ambrosia Dalo and Lemmertjan Dam shows very clearly, that companies with higher ESG scores tend to deliver lower average returns than those that have lower ESG scores. They found that for a company, ’a one standard deviation decrease in the ESG score is associated with a 0.13% increase in monthly expected returns’. Pair this with an increased P/E ratio for most sustainable shares compared to shares of companies of equivalent profitability and we start to understand why ESG’s may be out of the question for some investors. There is also a limited amount of diversification to one’s portfolio when they invest solely in Stocks and ETF’s which have a high ESG grade. This can put an investor at great risk of a loss in returns.

However, it’s important to keep in mind that the value that the ESG criteria can give an investor lies in the likely prospect that investing this way will pay back sizeable returns in the long run while creating a more sustainable and ethical future in the process.


Current developments:

With the current geo-political and economic upheaval, we are seeing many wealthy investors change where they are investing their capital.

  • Blackrock seems to be leading the way with ESG commitments. As the world's largest asset manager, they are speeding up this sustainable shift and encouraging the market to follow suit. Their sustainable assets more than doubled in 2021 and are currently managing more than £450 worth of high ESG stocks.

  • Data from Savanta shows the confidence wealth managers generally have about the increase in sustainable investing even in these unprecedented times. In a survey conducted after the Ukraine invasion, about 80% of 27 wealth managers polled said they expected interest in ESG among their clients to increase in the next 12 months.

  • With the recent spike in oil prices, many investors that had their money tied up in oil are liberating their stake in oil and are reinvesting the new capital into industries that align more with their values.

  • As the younger generations gain a larger share of global capital, we are seeing a more progressive push to change the framework of investing. Many wealthy families are also listening to younger members more. This determination by so many to make our world more sustainable at the cost of short-term returns is having astonishing consequences on the market with 1/3 of invested assets being defined as sustainable.

  • Firms like PFC are looking at asset classes that can meet ESG criteria while still delivering healthy returns during times of rising inflation. Green construction and real estate among other asset classes and commodities have been increasingly considered by many institutions like PFC. Some speculate that even after these turbulent times, these green asset classes will continue to be a more popular choice for investors.


Summary:

The current geo-political and economic state of the world is testing the moral integrity of investors who are struggling to make their desired returns in the sustainable ESG market. Still, many have doubled down on their risky and slow growth investments with the knowledge that their money is doing some good. The trends show that ESG investing may be the way of the future of investing. Whether the ESG criteria have the right parameters is subjective and is often debated, but your capital is a vote on how this world will continue to be shaped and we are going in the right direction if we are considering our morals into this vote and not just profitability.



Useful links:


How two different companies vary in grading methods:




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