ESG investing: weighing up what matters
Written and accurate as at: Jun 09, 2022 Current Stats & Facts
Recent local and global events have brought back into the spotlight the impact we have on our planet and people.
More than 90 per cent of surveyed Australians are concerned about the environment and sustainability*. But it’s not just consumption Aussies are becoming more conscious about—there is growing awareness that where we put our money can also have a positive or negative impact on environmental and social issues around us, both domestically and internationally.
From our bank accounts to super funds and other types of investments, more of us than ever before are choosing to invest responsibly^. Seventeen per cent of surveyed Australians have responsible investments, and over a quarter (26 per cent) are also planning to invest in responsible investments in the next 12 months#.
The ESG approach to investing
When it comes to investing responsibly, you may have heard a few different terms; ESG investing, sustainable investing, ethical investing, and social impact investing, to name a few. While they do have some differences, generally they refer to an investment strategy that takes into account positive impact alongside financial performance.
A common thread that some of these approaches have, is that they often use ESG (Environmental, Social and Governance) considerations as a framework for measuring the long term sustainability of an investment. ESG considerations can include:
Environmental considerations:
- Climate change, such as carbon emissions, energy efficiency, and product carbon footprint.
- Natural resources, such as water stress, biodiversity and land use, and raw material sourcing.
- Pollution and waste, such as toxic emissions and waste, and packaging material and waste.
- Environmental opportunities, such as renewable energy, green building, and cleantech.
Social considerations:
- Human capital, such as labour management and development, health and safety, and supply chain labour standards.
- Product liability, such as product safety and quality, privacy and data security, and health and demographic risk.
Governance considerations:
- Corporate governance, such as board, pay, ownership, and accounting.
- Corporate behaviour, such as business ethics, anti-competitive practices, corruption and instability, and financial system instability.
- Incorporating ESG considerations into your portfolio
One way to incorporate ESG considerations into investment decisions is through positive and negative screening—a process that includes (or excludes) industries, sectors, companies, countries, or regions that do (or don’t) meet an investor’s ESG considerations. For example, an investor may choose or wish to include and actively seek companies that demonstrate best practice towards climate change. Similarly, an investor may choose or wish to screen out companies linked to things such as armaments, gambling, or forced labour.
Importantly, in terms of the above, and achieving the desired outcome, consideration can often turn to investment ownership strategies. For example, direct investment in a diversified share portfolio or choosing a managed fund with ESG considerations.
The challenges with ESG investing
ESG investing is still evolving and maturing, therefore, assessing a company—or investment—based on ESG factors is, or can be somewhat of, a grey area. For example, a lack of regulatory requirements and demand for data transparency, on a global level at least, means there is often no universal standard for how ESG factors are reported on, so it can often come down to the individual company leaders to decide how and what they choose to disclose publicly.
Furthermore, while ESG ratings can be helpful, this does not necessarily mean that they are without flaws. For example, and depending on the circumstances, the rating a company receives may not always be based on how the company manages ESG risks, but rather to what extent they report on them.
These grey areas can potentially leave the risk of ‘greenwashing’ wide open—meaning there may be instances of over-inflated and even misleading claims about a company’s sustainability practices. The good news is that new global standards by the International Sustainability Standards Board (ISSB) may be on the way*^. If implemented, the standards will make companies accountable for ESG reporting in the same way as they are for financial reporting, reduce the potential for greenwashing, and help investors make more informed choices.
Balancing personal values with financial goals
Sound investment decisions are often based on a number of factors, including, for example, our personal values, financial circumstances, how long we expect to hold our investment, capacity (and tolerance) for risk, and the returns we need to generate to meet our financial goals.
How much our investment portfolio is influenced by ESG considerations may depend on, and come down to, how important these issues are to us. If they are important, consideration may also be required in terms of striking an appropriate balance between our personal values and financial goals. Doing so may help with preventing our portfolio from becoming too concentrated and ensure it has a material (appropriate) level of diversification to protect our investments from avoidable risk.
A final word about ESG and profitability
While it would seem that currently there is no conclusive evidence to suggest a strong (or definitive) correlation between a company’s ESG characteristics and its long-term share market performance, one research study has found a link between ESG and the valuation and profitability of companies*#.
If you’d like to talk to us about ESG investing, get in touch today.
* https://mccrindle.com.au/insights/blog/sustainable-events-for-a-sustainable-future/
^ https://responsibleinvestment.org/wp-content/uploads/2022/03/From-Values-to-Riches-2022_RIAA.pdf
# https://responsibleinvestment.org/wp-content/uploads/2022/03/From-Values-to-Riches-2022_RIAA.pdf
*^https://home.kpmg/xx/en/home/insights/2021/12/issb-sustainability-disclosures-talkbook.html
*#https://www.msci.com/www/research-paper/foundations-of-esg-investing/0795306949
