The potential impact of an ESG policy on investment strategy

With such a widely divergent array of measures and standards that may be applied to ensure investment strategies align with the principles underpinning sound Environmental, Social and Governance (ESG) practices, which measures and standards may impact you (and your clients) the most?

There are already a wealth of insightful ESG opinions and analyses in the market- many of which go into great detail and address various points-of-view on the matter. Perhaps a good starting point here is to expand upon the key components that make up ESG investment management choices and decision-making processes, as follows:

  • Environmental: Encompassing issues such as climate change, natural resources, greenhouse gasses, pollution, waste management and marine life management.
  • Social: Aspects including human capital, social opportunities and product liability.
  • Governance: Factors addressing corporate governance and board composition, corporate behaviour, diversity and politics.

When putting an ESG portfolio together, a savvy investment manager will take into account the risks and quality of potential holdings, using a combination of internal scoring methodologies (for example, a detailed analysis of a business's client base, supply chain and competitors) and external ESG benchmark indices. These benchmarks are put together using independent third-party analysis that aims to assess the performance of businesses with measurable ESG statistics.

The challenge, however, is that while measuring financial performance is based on globally standardised accounting practices, ESG measurement has no industry or standardised measurement methodologies in place yet. Thus, ESG conclusions drawn by an investment manager may be considered by a client to be subjective opinions and as a result inherently unmeasurable, no matter how rigorous the ESG measurement methodology may have been.

Subjective opinions notwithstanding, many investment managers and clients view companies with robust ESG practices embedded in their operations, particularly ESG practices that address good corporate governance and sound financial management, as having better risk management and as such delivering better performance.

However, there are many different ways to measure ESG practices, and what attracts one investor may not be at all attractive to another. Indeed, some clients have very specific and highly personal investment values and investment goals in which financial returns may not be a key driver and instead addressing and solving social or environmental problems is equally, if not more, important. Investment advisors to such clients must apply attention to meeting these ESG objectives alongside delivering good financial performance.

Investors with a strong ESG focus may find that their choice of available investment opportunities narrows somewhat depending on their ESG requirements. This in turn can result in the investor's portfolio becoming concentrated on a small number of sectors and/or firms, with an increase in risk and potential impact on performance.

In 2015 the United Nations General Assembly adopted a set of 17 Sustainable Development Goals (SDGs), also known as Global Goals. These interlinked goals are designed to be a "blueprint to achieve a better and more sustainable future for all" to be achieved by 2030.

According to informed estimates, the costs of achieving the SDGs will amount to some $4 trillion by 2030. Now, because of the global and multi-facetted scope of the SDG project, as well as the enormous costs involved, it is clear that measurement of the degree to which SDG goals are being achieved as the project moves towards its 2030 deadline is of critical importance.

Given this, the World Economic Forum issued the September 2020 publication 'Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Reporting' which sets out its stated objective of agreeing on a core set of common metrics and disclosures of non-financial factors for investors and stakeholders. These metrics aim to improve the benchmarking of sustainable business performance and will also facilitate the consistent and accurate tracking of investment contributions to the 17 SDGs. The core and expanded metrics agreed upon include:

  • People: Reflecting a company's equity and its treatment of employees. Metrics include diversity reporting, wage gaps and health and safety.
  • Planet: Reflecting a company's dependencies and impact on the natural environment. Metrics in this pillar include greenhouse gas emissions, land protection and water use.
  • Prosperity: Reflecting how a company affects the financial wellbeing of its community. Metrics include employment and wealth generation, taxes paid and research and development expenses.
  • Principles of Governance: Reflecting a company's purpose, strategy and accountability. These metrics include criteria measurement and ethical behaviour.

Pleasingly, a growing number of groups across the world are indicating their support for standardised paradigms of ESG performance reporting and by extension the establishment of a comprehensive standard of corporate reporting regarding all aspects of the work done by the organisations working to achieve the 17 SDGs, along with their investors and other stakeholders.

It is clear that ESG issues will continue to play an increasingly important role in influencing the decisions and recommendations made by investment managers. In addition, the ongoing progression to codifying a standard of measuring the success with which ESG investments achieve their goals is becoming an ever-more important goal to work towards. Investment managers would be wise to take note - and do the right thing.


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