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Five reasons why ESG isn’t going away

22/06/2018

In recent years we have seen a rapidly increasing focus on responsible investment by investors, wider society and regulators. This responsible approach has been underpinned by the incorporation of Environmental, Social and Governance (ESG) factors in the investment process. Growth in ESG investing is being driven by a number of factors, and it is unlikely to change course.

ESG has emerged as a dominant framework for assessing the long-term sustainability of an organisation. As of February 2018, €372bn was invested in ESG strategies in cross-border and domestic Europe, according to finance industry servicing company Broadridge, up from €132bn in 2010. The question is, what is driving this rapidly increasing focus on ESG, and is this just a short-term fad, or are we beginning to see the new normal in investment thinking?

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New Risks and traditional valuation models

It is through understanding the ESG elements affecting a business that these non-financial risks can be properly understood and mitigated. Has a company positively or negatively contributed to climate change? Does the company have effective cyber-security in place? Or as companies become increasingly global with longer supply chains, how do they ensure that child and slave labour are not producing their products? These types of issues can, potentially irreparably, damage a company’s reputation and social license to operate. In the modern world, that can spiral out of control in ways that just weren’t possible 20 years ago.

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Social media and the 24-hour news agenda

We live in an ‘always on’ world, where 24-hour news cycles demand a constant flow of information. Where in the past a company’s misdeeds may easily have been overlooked, they are now flashed on the feeds of millions of potential customers and investors, with the possibility of sparking outrage, backlash and boycott. Companies like VW, Facebook and United Airlines have all recently felt this power, and its negative impact on their share prices.
 
 
 

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Demographics

According to Morgan Stanley’s Sustainable Signals 2017 report, increasing interest in ‘sustainable investing’ is being driven by millennials, with nearly nine in ten ‘interested in sustainable investing’, with those very interested rising from 23% in 2015 to 38% last year. The report also found that millennials were twice as likely as the overall investor population to invest in companies targeting social or environmental goals.

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Increased understanding that ESG makes economic sense

As ESG investing moves beyond the perception boundary of ‘ethical’, and as people come to more fully realise the benefits of an integrated ESG approach, the belief that responsible investment involves a ‘financial trade-off’ should start to dissipate. This is backed by a growing body of research. As an example, one recent Harvard University study - Corporate Sustainability: First Evidence on Materiality found that ‘firms with good performance on material sustainability issues significantly outperform firms with poor performance on these issues, suggesting that investments in sustainability issues are shareholder-value enhancing.’

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Fiduciary duty

The European Commission’s High-Level Expert Group on Sustainable Finance’s (HLEG) 2018 report included measures to “clarify asset managers’ and institutional investors’ duties regarding sustainability”. Future plans could well include codifying fiduciary duties for asset managers to explicitly integrate material ESG factors and long-term sustainability into their investment processes.

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