Investing on the basis of environmental, social and governance factors – or ESG for short – allows investors to use their wealth in an active, objective-driven way. It does not have to mean compromising on performance.

 

Published to coincide with the COP23 meeting in Bonn this November, and including a contribution from the German Ministry for the Environment, our report explains why the importance of ESG investing is likely to grow even further.

 

“Being socially responsible does not have to mean compromising on performance: this is not philanthropy.”

We argue that digitalization is keeping investors aware of the underlying issues and that they are also aware that being socially responsible does not have to mean compromising on performance: this is not philanthropy.

 

As the report explains, there are multiple approaches to ESG investment, differing in method as well as objectives. Most investors are aware of the entry-level approach of exclusions, which filter out securities that don’t meet a set of criteria. But you can also follow an ‘adherence to norms’ approach, which provides a standardized approach to constructing a portfolio based on companies meeting various standards. There is also a ‘best in class’ approach, which takes an active approach in measuring companies’ ESG measures against their corporate peers. In addition, thematic investing can be used to focus on an area of specific interest to the investor. Engagement and impact investing is aimed at achieving a specific, measurable and targeted impact on society or the environment.

 

“The potential for fixed-income ESG investments is vast and still partly untapped.”

 

The choice of asset class matters too. Intuitively, most investors think of equities when considering ESG investments. But listed companies tend to be large entities, spread across many areas – some ESG-appropriate, some not. Bonds, by contrast, can be used in a targeted way (on particular projects) and with yields linked to a range of criteria. The potential for fixed income ESG investments is vast and still partly untapped. Other investment approaches may suffer from being less liquid.

 

“Performance can meet or exceed comparable traditional investments.”

 

As we point out in the full report, ESG is a rapidly growing sector and studies suggest that performance can meet or exceed comparable traditional investments. This may stem from effective corporate governance, motivated customers and employees or an ability to anticipate future regulatory change. A range of agencies now exists to rate companies on an ESG basis, along with multiple ESG market indices. But risks still exist around ESG assessment, or from the unintended consequences of ESG investment.

 

We think that ESG investing is here to stay. It is a common saying that people overestimate innovation in the short term but underestimate any longer-term impact. On this basis, investors who worry that ESG is currently overhyped will acknowledge its longer-term potential. A slow and gradual evolution of financial markets towards a better understanding of ESG issues will present opportunities for investors whose understanding evolves just a little bit faster than the average.

 

Executive summary from CIO Insights Special ‘Act today to ensure our future: understanding ESG’, published November 2017.


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