ESG investing is an approach to investing that places an emphasis on a number of non-financial factors that span environmental, social and governance. When analysing investment opportunities, these considerations are overlaid for risk and growth opportunities.
This area of investing has picked up momentum in recent years as a result of greater attention towards key issues, both home and abroad, including climate change, social unrest, and corporate controversies.
At the same time, the focus in this area has also spurred on and accelerated ‘responsible’ change within the corporate realm, while also leading to advancements in a number of industries and sectors to keep up with shifting attitudes and values.
The framework with which investors undertake ESG investing varies widely, which is only natural given some of the subjectiveness across this area of investing. However, at the heart of ESG investing is a direct focus on metrics that, although not necessarily mandatory for many companies, have become expected as disclosures necessary for investors to assess and consider against broader standards.
From an environmental perspective, every business has an impact on the planet through its conduct and its operations, which are driving forces behind energy consumption and greenhouse gas emissions.
While that is more apparent in some industries than others, mining for example, more companies from a diverse range of industries are coming to the realisation they also have their role to play. These sort of considerations are being picked up through an evolving set of metrics, including things like water consumption, biodiversity loss, pollution and waste management, among others.
The emphasis here comes amid an ever-growing focus on emissions and climate change, including a commitment towards net-zero. Companies are being urged to do their part to reduce their carbon footprint.
Although environmental considerations often dominate the narrative when it comes to the framework associated with ESG investing, social considerations are another part of the equation that should not be overlooked.
A company’s social impact might sound as though it has little relevance to its ability to generate money at the top line, however, companies have control over a number of areas that ultimately affect performance. For example, data breaches, incident rates, crisis management, and employee turnover are widely recognised as headwinds that are not only likely to illustrate broader problems, but stifle operations.
Although governance was once viewed with a narrow scope in a commercial sense, this area has evolved markedly in recent years as more scrutiny is directed towards companies in an effort to address matters like equality, remuneration, disclosure and whistleblowing.
These are matters that lend to credibility and image issues. Many companies have sought to address governance matters through clearer and more representative policies, including a conscious effort to be transparent around executive pay, and promote greater gender representation at board level.
What catalysts are driving ESG investing?
A number of movements have been central to the growing interest in ESG investing, including but not limited to:
- Political mandates and changing policy (e.g. emissions and net-zero)
- Visibility of natural disasters (e.g. Australian bushfires)
- Corporate controversies (e.g. Rio Tinto destroying an indigenous site)
- COVID (e.g. how the financial system is linked to sustainability)
- Technology and emerging new markets (e.g. electric vehicle development, low/zero-carbon mining, novel biopharmaceuticals and plant-based meat)
- Increasing inflows and the relative outperformance of ‘responsible’ investment funds in Australia (shown below)
Why should investors consider ESG?
Apart from the ethical considerations that come with ESG investing, which are central to the values of many investors, there are also a number of reasons to believe that ethical investing can help investors identify high-quality businesses.
Companies will face great difficulty in being able to thrive and grow if they do not afford the necessary attention to environmental issues such as climate change and resource scarcity, social issues such as OHS and employee engagement, not to mention governance issues including board quality and strong policies against corruption.
More specifically, these factors have an influence on businesses through their operations.
ESG considerations have the potential to impact future revenue and cash flow of a business, for example, if it means they are engaging in activities that will face growing pressure to stamp out. Coal stocks are often viewed under this lens, and while they may be enjoying record prices at the moment, many believe the shift to renewable energy will impact this sector over the long-run.
At the same time, image and accountability are matters that can dampen performance. Think of Westpac’s (ASX: WBC) scandal surrounding money-laundering and child exploitation, which not only saw the bank hit with a significant fine, but prompted a large number of investors to rotate out of the stock. Some would even say the bank has underperformed its peers since its social-governance problems came to light.
There is also the potential for ESG matters to disrupt supply chains and contracts for companies, which ultimately underpin their long-term growth prospects.
All told, a large number of investors believe that ESG investing can also shape an impact on things like the climate and social change. This is also why a significant shift has taken place in the superannuation sector, where funds are now taking a lead in terms of ethical investing.
But for retail investors, the benefits of ESG investing are quite evident:
- to reduce one’s risk exposure to adverse events and out-of-favour activities;
- to identify companies with sustainable business models; and
- to look for opportunities at the forefront of change
How you can assess ESG investments
While there is alignment in the three areas that account for what many perceive as ESG investments, there is still an element of subjectiveness in the detail.
For example, sectors that may on the face of it seem to go against ethical considerations, could be viewed as ‘responsible’ or ‘ethical’ depending on their final contribution towards society. Battery metals is one area that speaks to this concept, with mining in this segment at the heart of a transition to electric vehicles.
Meanwhile, you can now use SelfWealth’s ESG rating tool to track how companies measure against an expansive framework that takes into account hundreds of ESG metrics, as well as any controversies from recent years.
In conjunction with leading global data provider Refinitiv, our user-friendly ESG rating system makes it quick and simple to assess thousands of global businesses using a letter-grading system to see how they are meeting their commitments to environmental, social and corporate responsibility issues.
To see the ESG rating tool in action, simply login to the SelfWealth share trading platform, search for a stock by ticker, and scroll to the bottom of the page where you’ll find a breakdown on that company’s ESG performance, if available.
Improve your investment experience by incorporating a whole new realm of data today!
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