Environmental, social and corporate governance. Or E.S.G.
These are the trendiest words in finance.
Supporters say that being ethical and being profitable need not be mutually exclusive,
benefitting stakeholders, society and the planet.
But critics argue that these products are not that different from other investments,
and complain that it can be hard to measure whether a company is actually doing the right thing.
So, is ESG just good branding?
The idea of investing based on a set of principles,
and not merely for profits, is as old as the concept of investing itself.
In the 18th Century, Christian groups such as the Methodists and Quakers articulated this idea
with clear guidelines to their followers, and it has been gaining ground ever since.
The pressure to avoid giving capital to South African companies between the 1970s and 1990s
is seen as a factor that contributed to the end of apartheid.
More recently, the impact of our day-to-day lives on the environment has been the center of attention.
And that is affecting how investors allocate their money.
There is this increasing understanding in society that we need to care about the climate,
about social conditions of employees, so this has shifted the focus also
of the investment management industry. And second, the understanding based on academic research
that if you integrate ESG factors, you can generate higher performance and lower risk.
This awareness has led fund managers to create financial products which invest
in companies that meet their criteria of being ESG-friendly.
And more investors are adding ESG funds to their portfolios.
The share of global investors that applied ESG criteria to at least a quarter of their total investments
jumped from 48% in 2017 to 75% in 2019.
In the U.S., professional investors are expected to expand their holdings of ESG assets
from $12 trillion in 2018 to $35 trillion by 2025, or 50% of their total investments.
These numbers were calculated before the coronavirus pandemic,
but the health emergency could further accelerate this trend.
Has Covid in a way impacted this interest in ESG in any way?
Do you think it could actually make investors even more interested?
Absolutely yes, it’s certainly served to elevate and really put a spotlight on the way companies operate.
This emphasis that we have been hearing about for some time, this idea of corporate purpose,
you know, intentionally contemplating the needs of a broader universe of stakeholders,
broadening the aperture of how you think about enterprise risk, opportunity, disruptions
that could compromise your ability to meet your strategic objectives.
And Covid has certainly put that sort of set of considerations in the spotlight.
So, how does an ESG fund actually work?
The principles of ESG are really an underpinning for how stocks are selected.
Looking at ‘G’, the governance, of how the management of those companies works.
Looking at the ’S’ has become incredibly important during the pandemic,
thinking about how the company is interacting with all its stakeholders,
including the communities it operates in and its employees.
And then the environment and environmental policies and actions by companies.
So really, it’s become a much more thorough and integrated part of the evaluation of companies
that get put into portfolios that become ESG funds.
The investment profiles of the world’s four biggest ESG funds have changed over time.
For instance, about a decade ago, they included substantial stakes in major oil firms.
In 2007, the largest ESG fund had almost 13% of its total investments in companies
such as Royal Dutch Shell, Total and ExxonMobil.
But this has fallen in the years since, and the share of oil companies featured
in this particular ESG fund’s holdings has shrunk to less than 3% as of July 2020.
But how can funds that claim to promote sustainability
ever support oil firms,
which are widely seen as responsible for soaring levels of pollution?
When you think about the composition of ESG funds it’s first of all important to remember
they are still meant to be a fund invested to get a return for the portfolio
and so they can tilt based on industry groups, based on sector views
and that may or may not relate to an ESG view.
Ultimately, ESG funds, like all other investments, are meant to generate profits.
In fact, ESG funds have slightly outperformed other funds over the last two years,
at least in part thanks to their holding of tech stocks which have rallied strongly.
But a portfolio manager told us investors need to think about returns in the long-term.
As a believer of ESG as a firm, I like to read all these articles,
but I think it is a bit of bias in terms of the analysis simply because these ESG products,
they have lower energy exposure, and the energy sector was hard hit this year because of Covid.
On the other side, many of the tech companies, they get a high ESG score because they had already in place,
you know, working from home policy, they are more keen in terms of, you know,
taking care of their employees because that’s what they have, right, all of these tech companies, so they score high.
Since 2010, the fourth-largest ESG fund in the world has increased
its exposure to tech giants from about 8% to more than 17% within a decade.
Online retail giant Amazon was one of these big tech firms seen as ESG-friendly,
even though the company registered a carbon footprint of over 50 million metric tons of CO2 in 2019.
And with emissions rising by 15% compared to the previous year, the environmental concerns aren’t going away.
We don’t have clear standards on what is good, what is bad in terms of ESG.
Which also means that for investors looking into these funds, they need to look carefully at how they define it.
So if you look at Amazon as an example, maybe one fund says they are doing a fantastic job in terms of ESG
and another one may say, ’well we disagree,‘ but because there are not these obvious standards,
you know, you see even in high ESG funds, very different portfolio shares of firms like Amazon.
In the case of Amazon, its commitment to reduce its carbon emissions and become carbon neutral by 2040
is seen by some asset managers as a reason why the stock meets the definition of being ESG-friendly.
We could look at companies and say ‘your carbon footprint today is not satisfactory’.
The old way that investors addressed that was often by taking their money out of those companies.
Today divestment isn't seen as the optimal way to push for change.
Engagement and stewardship by investing and asking for a clear timeline for improvements
in things like carbon footprints is a much more, we will call it 2.0 way,
of thinking about using capital in the ESG space.
These subjective judgments give rise to another criticism
leveled at ESG investing: it often lacks transparency.
We look, at a company level, at about just over a thousand different data points,
and when I say a thousand different data points, this is what we really look for companies to publish.
Now what we observe is that companies don’t publish all of those data points
and actually how much of their data is published in itself
tells us a number of important insights into how companies implement ESG.
Do you care about a carbon footprint of a particular company?
Absolutely. So, the carbon footprint comes actually in at several levels.
Because one of the things we are very conscious of is when people can, or companies can very much
hide their carbon footprint by outsourcing certain parts of their production process
to other companies or other jurisdictions and that in itself is not a good,
not a good sign, not a good thing.
Organizations such as the United Nations and the European Commission
are promoting common standards to address these concerns.
At the moment, some feel there’s not enough disclosure
from fund managers about why their products should be considered ESG-friendly.
Investors may also need to do some more background work
to ensure they’re putting their money in funds that meet their ethical objectives.
And this is where further regulation could add some more clarity.
We've largely seen the regulatory momentum taking place in Europe.
We're starting to see some momentum in the U.S., but I do think that U.S. companies,
absent regulation, are not waiting. And I think companies certainly see
that there are broader global trends, there's opportunity, this is not going to be just a compliance exercise.
Hi everyone. Thank you so much for watching.
Would you invest in an ESG fund? Let us know in the comments section
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