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Environmental Social Governance: The Changing Attitudes of Investment Funds

 

Environmental Social Governance (ESG) Investing has shifted from a bit part player in investment screening to mainstream practice for investment decisions.  The influence of activists, NGOs and media campaigns on the environmental scandals of large corporations has meant corporates can no longer avoid adhering to ESG principles, and in particular, addressing climate change. The actions of NGOs create public attention and deliberately expose the biggest players.

Plastics is the perfect example, their inherent potential to pollute the earth has been known for decades, yet the pressure for corporations to change their production and business models has only become prevalent in recent years. This is largely down to NGO campaigns and media coverage. (The same has happened on plant-based diets – check out our article on planetary health diets here).

However, pressure for companies to implement ESG into their business practices and models is now being applied from the other side of the coin. Investors and investment funds are increasingly integrating ESG into their investment screening and decisions. A company implementing and championing ESG principles indicates less risk, and therefore presents itself as a much more viable investment.

Visual example of how one investment fund, Hermes, determines how companies manage ESG risk.

Visual example of how one investment fund, Hermes, determines how companies manage ESG risk.

It indicates to investors a company is less likely to commit environmental and social mal-practice throughout their supply chains and operations, meanwhile upholding ethical governance policies and practices both within their internal structures (e.g. whistleblowing, executive pay, shareholder rights) and external behaviours (e.g. bribery, illegal practices).

It is undeniable NGOs set the tone on ESG, but investors now influence demand for sustainable and ethical business practices.

Why is this ?

There are two main reasons.

In summary, companies with good social and governance characteristics and strong track records of actions to mitigate their impact on climate change, generally outperform others based on ‘basis points’ (bps). This is a common unit of measure for investment returns and growth rates and therefore suggests to an investor a more profitable investment.

However, investment managers with ethical investment criteria will inherently look to ensure a company meets their specific criteria for an ethical investment. This underpins the investment decisions instead of basis points and investment returns. This is the major shift.

Interestingly, it is now widely accepted social factors are now statistically significant in company performance and how ESG practices impact shareholder returns. Previously environmental and governance characteristics of a business were the key players for investors. A companies social ‘risks’ can be so significant that they offset sound environmental and governance practices all together. Social factors now highlight badly performing companies during investment screening.

 

A Move from Government

In July 2019 the UK government released their Green Finance Strategy which sets out their plans to ‘green’ finance. One of the main intentions of this new strategy is to make corporate disclosure of sustainability performance mandatory within the private sector. The government intends to develop clarity on what and how companies should report sustainability performance. This is to allow investors to make ESG-information led decisions on investments. Through this, the government believes they can restructure our financial systems whereby environmental, social and governance factors are centralised into financial risk assessment. They argue this would hugely assist with achieving the legally binding net-zero carbon target by 2050.

Have a further read on the Green Finance Strategy here.

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