The concept of Environmental, Social and Governance (ESG) investing first surfaced in the beginning of 2004, and a year later the initiative produced a report to make a case of integrating responsible investing into capital markets for sustainable market growth and better outcomes for society. Initially, institutional investors were reluctant to embrace and integrate this concept into their investment process, simply because their mandate was to maximize shareholders’ value. Moreover, the lack of data and financial implications on businesses were added factors that remained major barriers for its integration into capital markets. However, rising evidence over the years that ESG concerns have financial implications, have led to a change in perception. Today, ESG or sustainable investing is a widely understood, acknowledged, and accepted concept within the investment processes and decision-making for both institutional investors and leading corporates.
In a world where rapid industrialization and urbanization threatens to continue leaving deep and scarring wounds on the environment, balancing conscience with profit has become of major significance within the global investment arena. ESG investing does not draw on an obligation of merely impacting social change and development, but rather builds on the financial aspect of investing responsibly, through models with robust financial strategies, policy, and decision-making, as well as social consciousness. For instance, an ESG assessment would consider a business’ handling of environmental issues like carbon emission levels and/or targets, water usage, energy levels, etc.; social issues including diversity goals, gender equality and human rights; and governance matters covering ethical practices, corruption and board diversity, among others. Investors can use this data to make informed decisions throughout the investment cycle based on their investment objective and mandate, and in terms of identifying material risks, allocation of resources, portfolio development and risk management, among others. The underlying notion is that when businesses adhere to ethical practices such as implementing carbon drawdowns and neutrality, waste reduction, preserving water, and more, they can be proven to be a safer investment in the long-term.
Once an extremely niche market, ESG investing has become more popular in recent times, and the awareness around this concept was especially heightened post the pandemic. A JP Morgan poll of investors from 50 global institutions showed 71% of responders in agreement that a low probability-high impact risk such as COVID-19, would likely increase awareness of high probability-high impact risks like climate change. Accordingly, 2020 witnessed a spike in the popularity of tools that enabled one to evaluate ESG opportunities, risks and threats, using AI, data analytics and similar technologies. Interestingly, the influence of ESG considerations on consumer behavior is also noteworthy, with a Prosper Insights & Analytics Consumer Survey recording nearly 32% of adult consumers willing to spend more on environmentally responsible brands; while millennials, the largest purchasing group, were firmer on this mandate, at nearly 40%. This is confirmed by S&P Global Intelligence research, which suggests that firms adhering to ESG considerations are usually better-managed, with stronger competitive advantages and healthier balance sheets than those of their non-ESG compliant peers, who can also witness an adverse impact on their credit risk and market performance.
Evidently, the ability to evaluate and judge companies based on their sustainable impact is becoming a key factor for investors in portfolio management and investment objective assessment across major investment funds. In view of this, an overwhelming proportion of corporates, business honchos and investors are now allocating significant funds towards ESG-dedicated investments within their portfolios. In recent years, the extreme and persistent damage to the environment has been manifesting quite prominently, most visibly in 2020, a year marred with bushfires, floods, hurricanes, earthquakes, and more. Moreover, the COVID-19 pandemic further disrupted the global economy, and underscored the importance of risk management, especially due to unforeseen risks from environmental factors. Accordingly, investing into funds and companies with ESG considerations grew in a major way in 2020. Another benchmark for understanding the growing commitment to ESG factors in investment decision-making and ownership, can be gauged from the number of organizations signing up to the United Nations-backed Principles for Responsible Investment (PRI) network. As of September 2020, the PRI counts >3,000 signatories with USD 103 trillion assets under management (AUM), up from just 63 signatories with USD 6.5 trillion AUM in 2006. Meanwhile, China, Brazil, Switzerland and Austria added to the list of countries with a commitment to a net zero carbon goal in 2020, while some of the arguably most notable achievements in 2020 were the new highs recorded within ESG investment inflows from April to June, along with ESG funds outperforming major global indexes in the year.
ESG investments witnessed groundbreaking inflows in 2020, with about 200 new ESG ETFs being launched in 2020 alone, and AUM propelling to a record USD 1.2 trillion by the third quarter. Global ESG indexes also managed to beat major market benchmarks performances during the year. Through September 2020, the S&P 500 ESG Index outperformed the S&P 500 by 2.5%, while the S&P 500 Paris-Aligned Climate Index outperformed the S&P 500 by ~5.6% in the same period. Overall in 2020, the S&P ESG Index outperformed the S&P by over 1%. Several other ESG funds also beat the S&P’s 2020 performance as of July-end (+1.2%), such as the Brown Advisory Sustainable Growth Fund (+20.1%), Nuveen Winslow Large-Cap Growth ESG Fund (19.7%), Putnam Sustainable Leaders Fund (10.8%), Calvert US Large-Cap Core Responsible Index Fund (+6.5%) and more. Such stellar performances, backed by growth that has remained consistent over the past few years, showcases the rapid evolution of ESG funds, and their immense scope for growth in the foreseeable future.
Going forward, the ESG story promises to be a compelling one, particularly with sustainability becoming such an important element of our everyday life. If ESG investing were to be unilaterally applied in investment, portfolio and business mandates across corporates, businesses, organizations and governments, the impact on global markets is likely to be mammoth in proportion, with the ESG 2021 Outlook by Bloomberg Intelligence Global projecting that ESG assets could top USD 53 trillion by 2025. This is likely to promote a healthy cycle of investing with a socially responsible mandate, enabling the sustainability phenomenon to continue to grow and evolve in years to come.
Most significantly, as the concept of what comprises value is shifting for consumers, it is the opportune moment for corporates to adapt their models to an ecosystem that promotes smarter, safer, and more responsible processes. Growing investment into businesses that maintain a focus on ESG factors, will exert pressure on ones that fail to modernize and revolutionize their models accordingly. As a result, companies that are environmentally and socially conscious, are likely to emerge successful and witness a sharp surge in market value and brand presence. In tandem, investors valuing such considerations will also benefit from their investment choices in the long-term.