More so than ever before, consumers all around the world are concerned about how companies are impacting the environment and social wellbeing of our planet.
ESG Investing: What is it?
Due to the concern that people have for the environment and the social wellbeing of the planet, businesses have developed a way to measure impact, and it’s termed ESG.
The acronym stands for Environmental, Social, and Governance, and companies are tasked with considering their impact across these areas to obtain an ESG rating.
And while it’s not a requirement for public companies to report their ESG rating, it’s widely considered a beneficial thing to do as impressive scores are likely to attract investors and portfolio managers, particularly those with an eye on ethical investments. Utilising the ESG rating of business to decide where to invest your money is known as ESG investing.
Although considering a company’s ESG rating as a parameter to begin activism investing is largely easy to digest, there are multiple grey areas that can cause confusion. Perhaps the biggest issue is that there is no uniform method of measuring ESG, and it’s incumbent on companies such as S&P Global, Bloomberg, Global 100, MSCI, Diligent, and Refinitiv to provide ESG audits.
The challenge lies in the fact that each company adopts its own scoring system when compiling ESG scores, meaning that ordinary investors would have to be well versed in each of the methodologies to truly understand how businesses rank against each other.
In spite of recent attempts to regulate ESG, more research and understanding is required on a global scale before regulation can become a reality. Regardless, few deny the importance of ESG metrics when it comes to performance analysis and the determination of whether or not a company is complying with sustainable best practices. Crucially, ESG metrics are there to provide assurance to investors that they are indeed spending their money line with their principles and ethics.
How does ESG influence financial markets?
In the not so distant past, it was accepted that if you were to make your investment decisions solely on ESG metrics, then you were essentially required to forfeit your potential profits in favour of the greater good. But today, this is no longer the case. For instance, 43 investment companies – including Vanguard and BlackRock – are pledging to hit net-zero under the Net Zero Asset Managers Initiative.
As well as strong words from Vanguard’s CEO, the company has a track record of action in recent times, having backed Engine No.1 in a vote that unseated two of ExxonMobil’s directors. Not only did this make the corporate world sit up and take notice of the demand for ESG, but it also made the company refocus their climate strategy and clean up its act.
When you look at the numbers, it’s evident why ESG is now being taken seriously. Companies that emphasise ESG metrics are now worth around $35 trillion, which is equal to a third of all global assets. What’s more, a Morning Star study found that most sustainable funds have performed much better than non-ESG equivalents throughout the timeframe that was evaluated.
What does the future look like for ESG investments?
ESG investing will become even more crucial as current threats to the climate and inequality continue to be perpetuated throughout the world. Following the release of the UN’s Sustainable Development Goals, companies all around the world claimed that they would readily align with them in no time at all. But ascertaining which companies truly meet the stipulated targets isn’t easy, which shows that improved transparency is required when it comes to reporting and measuring environmental and social impact. If greater transparency isn’t achieved, then the risk of greenwashing – corporate exaggerations about meeting green targets – will increase.
Specifically, some aspects of ESG that will benefit from improvement in the near future include:
- Defined objectives: The way that ESG objectives are currently written means they can be interpreted differently from business to business. For instance, clarifying what is meant by treating employees fairly or what a positive impact in underserved communities should look like would significantly increase transparency when it comes to ESG investing.
- Clear ranking system: Due to the variations in ESG scoring, it’s currently very difficult for investors to compare the performance of companies against ESG metrics. Approximately 50% of valuation experts agree that this is the biggest problem facing ESG disclosures in the future.
- Monitoring changes: ESG issues are far from stagnant and are ever-evolving, as exemplified by the Black Lives Matter movement. It’s of paramount importance that ESG scoring systems are regularly updated and reviewed to reflect societal revolutions.
The bottom line is that the future success of ESG investing will come down to demand. As more investors seek accurate and improved data regarding ESG metrics, then there will be more pressure on the financial markets to deliver what the investors request. Utilising pioneering proxy solicitations and supporting activist investments through innovative platforms like Tulipshare will help to drive change long into the future.