2023-04-10| Special

Why ESG Is a Smart Choice for Investors and Businesses

by Sahana Shankar
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Investing has gained a lot of attention from individuals in the last decade with e-commerce democratising the access to stocks, financial portfolios and investment information. Financial institutions need to declare their assets, investments and choice of financial instruments to ensure customer satisfaction. Both, investors and consumers are looking at ESG as crucial non-financial indicators of a business’s commitment to sustainability. It is no more an additional value proposition but is increasingly seen as a prerequisite to ensure profitability and positive financial performance. 

A Quick Look at the Origins of ESG

The term ESG gained credence after the Who Cares Wins (2004-08) report published by the International Finance Corporation and World Bank, as part of an initiative from the United Nations and financial institutions across the world. The report outlined a systematic view of how ESG integration makes financial sense for businesses and how business leaders, investors and regulators could contribute to this. The report identified several environmental, social and governance factors such as environmental performance, labour standards, transparency and disclosures, workplace safety, commitment to human rights and other issues that could be addressed in emerging market companies. 

Sustainable Investing

Investments which consider ESG factors during portfolio selection and management are classified as sustainable investments. 

The Global Sustainable Investment Alliance (GSIA) has consistently monitored the prevalence of sustainable investments globally and found that since 2016, global sustainable investments have increased by 55%. As of 2020, Canada leads with over 48% sustainably managed assets, followed by the US at 42% and Japan at 34%. Global sustainable investment has gone from USD 23 trillion in 2016 to USD 35 trillion in 2020 with 36% of all assets under management being sustainable. 

Related Article: The World of ESG: Standards and their Organizations

Evolution of Investing Strategies Based on ESG 

Financial institutions, private equity firms and individual investors are now more aware of ESG and are increasingly looking for sustainable investments. This has led to the development of new ways to differentiate between ESG-compliant and non-compliant options. Private equity firms such as BlackRock, Goldman Sachs, Bain Capital and TPG have launched ESG investments and impact investment funds, demonstrating that high net worth individuals and institutions are increasingly interested in ‘green finance’. The GSIA has enabled an inclusive definition of sustainable investing with many possible strategies such as:

  1. Negative and positive screening- exclusion of assets or companies considered unsustainable such as tobacco companies or weapon makers or selection of companies that are selected for positive ESG outcomes. 
  2. ESG integration- including ESG factors into the investment process
  3. Impact investment- an ambitious strategy wherein investors only invest in companies where ESG impact can be precisely quantified.
  4. Thematic investing- selection of companies that consider similar ESG issues
  5. Norms-based screening- Identifying companies which adhere to international norms such as those from the United Nations, International Labour Organization, Organisation for Economic Cooperation and Development etc

According to the GSIA, ESG integration remains the most popular strategy for investors, followed by negative screening while impact investing seems the least prevalent, given the difficulties is accurately measuring the impact from ESG policies. While norms-based and negative screening is more prevalent in Europe, USA focuses more on positive screening, impact investing and thematic investing. 

Policy and Regulations to encourage ESG investing

Most countries are developing policies to build frameworks to enable businesses to disclose their ESG policies to help investors compare risks and returns. Sustainable funds are provided with templates, labels and alliances such as the Net Zero Asset Owner Alliance to demonstrate their ESG credentials and attract investors. Since 2020, ESG-conscious consumers have spurred the demand for ESG products and investments. France and Germany report that two-thirds of retail investors would want environmentally sustainable investments, while in the US, 85% of individual investors would put their money in ESG compliant funds. Environment, gender, smart cities, the oceans and community development are the most popular sustainability-related themes for new fund offerings since 2020. 

A Renewed Business Perspective for ESG

With the pandemic upending business models for many sectors, business risks in 2023 are very different. This requires a widening of the scope of ESG issues that businesses need to consider. For example, business interruption, impact of climate change, shortage of skilled workforce are very real and possible risks that didn’t merit a lot of debate before. Hence, companies will need to rethink their ESG strategies to not just gain brownie points with investors but also to improve financial performance and adapt to a rapidly changing landscape. To attract more investors, companies now make their ESG metrics available. 

 A report from the NYU Stern Center for Sustainable Business compared data from over 1000 studies from 2015-2020 to investigate the relationship between ESG and financial performance and concluded that 

  1. the positive correlation of ESG investing and financial performance is more significant over longer time periods
  2. ESG serves as positive reinforcement and a potential protective cover during social or economic crisis.
  3. ESG drives better financial performance by contributing to better risk management and innovation.





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