Is ESG really necessary? US$80 trillion says it is

Above the Noise

Is ESG really necessary? US$80 trillion says it is

The days of treating ESG as a choice are numbered

It wasn’t very long ago that environmental, social and governance (ESG) matters were placed in the ‘nice but not necessary’ category when thinking about profitable investments. In other words, it was the domain of a particular – less hard-nosed – breed of investor, willing to trade returns for some more nebulous and value-tinged ends. 

Thankfully, perceptions have changed as more research on ESG has emerged. In a landmark meta-study reviewing the results of over 2,200 studies from 1970-2014, it was calculated that 90% found a neutral or positive link between ESG and corporate financial performance , and the large majority identified a positive link*.

ESG analysis is about trying to identify and evaluate areas of risk and potential opportunities that can often be overlooked in traditional financial analysis. Incorporating ESG considerations in investment analysis is not always a guarantee of better returns – as with any approach it may limit the types of companies held in the portfolio – but it does allow a clearer understanding of the risks that investors are exposed to.

It may seem obvious, but the opposite of sustainable is unsustainable. Try to argue the case for the latter.

Of the many players championing ESG in an investment context, the Principles for Responsible Investment (PRI) towers high, not least due to its formidable supporter base. The number of signatories to the PRI’s six principles has rocketed since its launch in April 2006 (from 63 to nearly 2,000) – now representing over US$80 trillion worth of assets. Yes, there is some dispersion in terms of the levels of activity of signatories – as reflected in the PRI’s annual ratings – but the broader message is clear: if you think ESG is a passing fad, think again.

 

Growing numbers of PRI signatories 

Source: PRI. Data to April 2018

Powerful platform

Martin Currie has been a PRI signatory since 2009 and experienced first-hand the benefits that a network of this size and heft can bring. While its core mission hasn’t changed, the PRI has continued to evolve with the times, and now offers a whole suite of support services for investors and asset owners, perhaps most prominently as an educational forum and a platform for collaboration.

We have participated in several of the PRI’s joint-engagement initiatives over the years, spanning various issues including fracking, employee relations and water risk. These collaborative efforts haven’t just been useful from a company-impact perspective but have provided excellent opportunities to learn and share knowledge with like-minded investors. Best practice is a moving target, and open dialogue – even with competitors – is key to staying abreast of a fast-changing world.

And we do believe it’s important to get stuck in. Last year, I joined the PRI’s ESG Engagement Advisory Committee, which, among other things, is responsible for coordinating collaborative engagements with listed companies. Our investment teams continue to lead the engagements with target companies in a couple of more recent initiatives, including cybersecurity and tax responsibility.

PRI In Person Conference 

The PRI’s flagship annual ‘in Person’ conference has become a real fixture on the investment calendar. We attended the 2018 event on 12-14 September in San Francisco, the agenda of which was carefully curated to cover the key debates facing investors with a focus on climate change, and additional sessions on diversity, barriers to ESG integration and tax transparency among other issues.

The Task Force for Climate-related Financial Disclosures (TCFD) generated much discussion. The initiative now has the support of over 500 organisations including corporates as well as asset managers and asset owners. Discussions centred on how best to tackle the different scenarios in the transition to a lower-carbon economy. The good news for investors is that there are some tools beginning to emerge, such as the Paris Agreement Capital Transition Assessment (PACTA) and the Transition Pathway Initiative (TPI) – both of which we will take a closer look at within Martin Currie’s integrated approach to ESG analysis.

There were discussions about the increasing impact of social inequality which has led to the formation of an agenda known as ‘The Just Transition’. This framework addresses the challenges that the shift to a lower-carbon economy may create for different elements of society, and is one of the ‘social’ considerations (the ‘S’ in ESG) that is increasingly coming into focus for asset owners and managers alike.

There was also debate on the increasing availability of ESG data and the use of external ESG ratings. Data consistency and reliability is still an issue – for example, there are low correlations of ratings between ESG rating providers. This suggests that there is no consensus on what ‘good’ looks like, that a strategy based on using these raw ratings is potentially flawed, and that asset managers need to do their own ESG analysis.

Finally, there were many references to regulation both with respect to increasing current regulation on responsible investment and the potential future pathways for climate-related regulation. A poll of attendees showed a large majority expect a disorderly policy response. This will be an area that we will continue to monitor closely.

It’s a hackneyed expression, but when it comes to many ESG issues we really are in the same boat, and the phenomenal traction gained by the PRI’s principles is testament to a growing consensus that these factors are of real consequence from an investment perspective.

In short, the days of treating ESG as a choice are numbered.

*Friede, Busch and Bassen, 2015

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