Investments and the ESG Factor

It is clear that social responsibility is a topical issue at any level . . . it is an issue that you should address within your organisation.

Investments and the ESG Factor

Would you trust a company that does not care about employee welfare, gender equality or fair compensation policies? Would you invest in a chemical company that makes no effort to mitigate its environmental impact?

In recent years there has been a growing focus on environmental and human rights issues, which has also led to a radical change in the financial and investment market.

Companies are being asked to take more and more responsibility for their “impact” and to make it as positive as possible, to the point where investors assess organisations not only on the basis of financial performance but also on the basis of non-financial criteria and the way they manage the related risks and opportunities.

In addition, there is a greater awareness of this issue in the Millennials and Generation Z to the extent that some financial analysts and investment managers offer advisory or investment lines dedicated precisely to these factors.

But what is an ESG investment?

ESG stands for Environmental, Social and Governance.

Socially responsible investment dates back to the 1960s, when investors began to avoid companies with negative reputational factors (e.g. companies involved in the South African apartheid regime). Much has been done since then and in 2015 the United Nations officially established 17 Universal Sustainable Development Goals.

Investors are increasingly applying these non-financial factors as part of their investment analysis and selection process and, while ESG metrics are not mandatory in reporting, more and more companies are publishing specific data on ESG factors.

ESG towards SRI

ESG investment originated from Socially Responsible Investing (SRI) philosophies, although there are fundamental differences.

SRIs typically use negative value judgments and screening to decide which companies to invest in while ESG investment seeks to find positive value in companies that apply socially responsible principles.

SRI filters and excludes companies that do not meet certain criteria from portfolios while ESG opts for realities defined as “impact” based on the three relevant areas:

– Environmental factors (Environment), refer to the company’s behaviour on issues related to resource depletion, climate change, waste and pollution.
– Social factors (Social), are related to the company’s treatment of people, workers and local communities, including health and safety issues.
– governance factors (Governance), relate to corporate governance and policies, including tax strategy, corruption, structure, compensation.

Why integrate the ESG factor into your business model

It is clear that social responsibility is a topical issue at any level (financial, regulatory, etc.) and, regardless of legal requirements, it is an issue that you should address within your organisation.

As many investors are incorporating ESG factors into the investment process, integrating sustainability elements into your strategy can certainly have an impact on your income.

This requires a change of mindset: ESG should be seen as an investment rather than a cost because it allows you to achieve a number of benefits, including increased market confidence and a better reputation.

But does the ESG factor generate excessive returns for investors?

It is not possible to become an ESG champion overnight.

It takes time to grow your ESG culture and create a team dedicated to investing in long-term initiatives to drive shared value creation.

ESG organizations seek to avoid short-term, low-cost thinking.

Instead, they imagine the cause and effect of the company’s actions and seize stakeholder-centric value creation opportunities while avoiding stakeholder risks. Shareholders continue to thrive, though not at the expense of employees, customers, suppliers, the community or the planet – and usually over a longer time horizon.

Therefore, even studies that analyze ESG factors in the analysis of possible over-performance or underperformance struggle to capture all aspects of this new corporate philosophy and certainly in many cases the added value of an ESG culture is not yet reflected in the value of actions.

To date, not all scientific analysis and publications support the idea that ESG factors always lead to better equity returns. There are many variables at stake, including simple elements such as time and the fact that not all stock market operators are good stock market operators.