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For many, the 2004 published UN Global Compact report: “Who Cares Wins: Connecting Financial Markets to a Changing World” marked the birth of a corporate ESG approach and sustainable investing.
It also delivered a compelling message: Embedding environmental, social and governance factors leads to more sustainable markets as well as creates better outcomes for societies and makes good business sense.
A little bit more than a decade later, the yields of sustainable assets compared with their more traditional, non-ESG counterparts emphasises the strong business case for sustainable investing. In this article we examine how a strong ESG proposition creates value for both companies and their investors.
GSIA: The Global Sustainable Investment Alliance, a collaboration of membership-based sustainable investment organizations around the world, aims to deepen the impact and visibility of sustainable investment organizations at the global level.
UN PRI: The UN PRI organisation is the world’s leading proponent of responsible investment. It helps the investor community to understand the investment implications of environmental, social and governance (ESG) factors and supports its international network of investor signatories in incorporating these factors into their investment and ownership decisions.
CFA Institute: The CFA Institute is a membership-based organisation for the investment profession. It promotes the highest standards of ethics, education and professional excellence in the investment profession for the ultimate benefit of society.
IA: The Investment Association is the trade body and industry voice for the UK’s leading investment managers.
Pensions Climate Risk Industry Group: The group, established in 2020, has recently produced draft, non-statutory guidance on assessing, managing and reporting climate-related risks in line with the Taskforce on Climate-Related Financial Disclosures.
ESG creates value
Over recent years, a number of research reports have documented and continue to outline that an ESG approach not only is key to achieve building a more environmentally and socially sustainable society, but, in fact, also helps companies to improve their financial performance:
- Companies with strong ESG credentials have on average outperformed by 14.4% in emerging markets and 5.2% in developed markets from June 2013 to February 2018.
- Aggregated evidence from more than 2000 empirical studies about the correlation between ESG and financial performance shows that the vast majority confirmed a positive correlation, with less than 10% reporting a negative finding.
But how exactly does a strong ESG proposition create value for companies and their investors? The main reasons are:
- Mitigating risk: The use of ESG principles helps firms to evaluate future risks and to avoid regulatory and legal intervention
- Reducing costs: Apart from lower capital costs due to lower risks, applying ESG principles leads firms to review and modify corporate processes, such as for example building more efficient supply chains or using resources more efficiently, hence reducing costs on the way.
- Increasing attractiveness with consumers resulting in top-line growth: The public consciousness has changed. Consumers have begun scrutinising the sustainability credentials of the brands they buy.
- Improving productivity: A strong ESG proposition not only helps to attract and retain high calibre employees, but also enhances employee motivation and productivity overall
- Strong-performing, ESG-compliant companies achieve a higher share value and, as top-performers, will be included in benchmark indexes - making them even more attractive for investors
Bullish sustainable investment market outperforms its conventional rivals
While the extraordinary growth of sustainable investing is continuing – in particular in Europe, which accounted for 76% of all sustainable funds by count, 81% of assets, and 72% of the first-quarter flows in 2020 – the word about the likely “win-win”, doing good while enjoying positive returns, is spreading amongst investors. In a Schroders study, 47% of the 23,000 private investors surveyed said that they’re attracted to sustainable investments because of their wider environmental impact, while 42% felt the reason they were attracted to sustainable funds is because they are also likely to offer higher returns.
Indeed, ESG funds are proving to outpace their more conventional funds rivals – not in every sector but for a majority – on a ‘positive impact’ level as well as in respect of return on investment: In the first eight months of 2020, the average ESG funds globally in the Investment Association (IA) Global sector delivered a 10.10% return compared to a 4.09% return on average from conventional counterparts. And while investors putting money in the 19 ESG funds in the IA UK All Companies sector were faced with losses in that period, these were – with an average loss of 14.15% – lower compared to the average 17.30% drop in value of their traditional peers.
A comparison between sustainable indexes and their non-sustainable counterparts presents a similar picture: Over the course of 2020, 81% of a globally representative selection of sustainable indexes outperformed more traditional indexes. This outperformance was even more pronounced during the first quarter downturn, emphasising the resilience of sustainable funds in the face of adversity.
The same holds true while looking at data from the past five years: ESG-focused indices consistently either match or exceed the returns made by their standard counterparts, amid comparable volatility. ESG portfolios also show more resilience in market downturns.
Furthermore, looking at longevity, sustainable funds have proven to be frontrunners again: 72% of sustainable funds available to investors globally ten years ago have survived, while only 45.9% of traditional funds achieved to last as long.
‘Sustainable investing’ will soon mean ‘investing’
The business case for sustainable investing is strong. However, a key challenge will be to ensure that issuers deliver what it says on the package: genuinely sustainable assets. Asset managers are at the centre of this challenge, faced with the difficulty to get the data required to set comparable targets and measure and compare the ESG performance of companies against peers, across industries and across different geographies. Furthermore, they must prove that they’re ESG-compliant too, and deliver ESG disclosures about their business practices to their clients.
The sustainability reporting landscape is constantly evolving with new and competing reporting frameworks and benchmarks striving for dominance. The resulting “alphabet soup” of standards and frameworks – such as the GRI, IIRC, SASB, TCFD and CDP – has created some confusion among corporates and investors as each standard can have different objectives and focus areas. But there’s good news for companies and investors alike: efforts are underway to help achieve greater coherence, consistency and comparability between financial and corporate sustainability reporting frameworks and standards, mainly driven by the initiative “The Corporate Reporting Dialogue”. What’s more, two of the most recognised standards, GRI and SASB, announced a strategic collaboration in July 2020.
The future looks bright: sustainable investing will not only mature as an asset class but will also see a further broadening of attractive investment opportunities that deliver return by doing good for our society.
And while ESG has just entered mainstream it won’t take long until it’ll become the norm, which have led some observers to already point out that ‘sustainable investing’ soon will simply be considered ‘investing’.
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Read the further articles in this series: