ESG: Better long-term outcomes?
Responsible investing is evolving. Few investors still talk about socially responsible investing (SRI) when targeting better behaved companies. Today the term environmental, social and governance, or ESG for short, is more likley to be dropped into those conversations instead.
The new term has been coined to encompass a wider range of factors, yet it is causing confusion. There is no universal term to define ESG. Is it about ethics? Is it for religious groups? Or is it for people who vote for the Green Party?
Not knowing what it is does not help investors to identify such companies or, more importantly, measure performance. This is an important point. Although investing in companies that have high governance standards, a diverse leadership team or a low carbon footprint is not a new concept, its popularity is growing.
Part of the attraction is that such an approach to making investment decisions is believed to reduce risk. This is why more and more fund managers are making it their business to explain how they implement ESG factors into their investment strategy when pitching trustees for a mandate. For a growing number of investors it is no longer seen as just an add-on, yet there are many who do not understand it and, as such, have left it off their agenda.
Some ESG managers look to the regulators to help move it into the mainstream. Regulators and law makers are taking notice with the Law Commission making recommendations in this area, the EU introducing the Shareholder Rights Directive and a parliamentary commission is examining how pension schemes are fighting climate change.
This can only be good news for those pushing a more sustainable investment agenda. Part of responsible investment’s evolution is that it is no longer about screening out certain companies or industries. This has put trustees at odds with divestment campaigners.
Shell and BP are widely seen as huge contributors to climate change and the risks for investors are clear. But will shareholders voting with their feet make the world a cleaner place? These energy giants generate huge cash-flows, which they reinvest into developing cleaner technologies. This is just one example of why engagement and not divestment should be at the heart of ESG strategies.
Another issue has been the difficulty in measuring the non-financial performance of a business. It appears that although better quality research is emerging on the impact such strategies could have on portfolios, ESG is still more belief than proof-led. A lot more work is needed before this changes.