Lately, a lot is being said about ESG (Environmental, Social and Governance) sensitive investing. Many claims are made about how people these days are more aware of environmental issues with one eye on global warming, etc. However, change begins at home with each and every one of us, we shouldn't just wait for others to change to save the planet. Regardless, this post is about ESG investing, so let's get to it.
The UN has published a list of 17 SDGs or Sustainable Development Goals. These can be classified into 5 categories called the 5 Ps - the focus is on People, Planet, Prosperity, Peace, and Partnerships. The goals are: No Poverty; Zero Hunger; Good Health & Well-being; Quality Education; Gender Equality; Affordable and Clean Energy; Decent Work and Economic Growth; Industry, Innovation and Infrastructure; Reducing Inequalities; Sustainable Cities and Communities; Climate Action; Life Below Water; Life on Land; Peace, Justice and Strong Institutions; and Partnerships for the Goals.
Socially Responsible Investing (SRI) or Impact Investing is effectively applying similar (but not necessarily the same) principles for value-driven investing. The goal is to do social good as you invest - integrating ethical and social causes into your investment framework.
ESG is a more broad-based structure within whose context people try to incorporate various aspects of the SDGs and the SRI frameworks to invest money in ways that benefit society and the planet as a whole.
Ben Felix explains some of the considerations in this interesting video:
A useful description of an ESG framework in practice comes from Stashaway, a robo-advisor in Singapore that went from starting up to over 1B$ in AUM in less than 5 years! (I am not affiliated with them).
Cliff Asness (AQR Capital) says in a recent interview, if you cut out a part of the investment universe that introduces additional constraints into the process and cannot by itself be value accretive. However, in recent years ESG is having an impact in the way corporates are able to raise funds.
Let's say you have 1M$ to invest. If cigarette making companies give you higher returns, you would invest there. However, if more and more people shun these investments on an ethical basis and money flows into say, Solar or Wind power companies, then the so called "sin industries" - cigarettes, gambling, etc. will have some trouble raising funds leading to an increase in the interest they have to pay, thereby raising their internal project hurdle rate, so less projects get funded and growth slows. Or so the theory goes. But if investors are all focused on the so called sustainability-friendly firms, this trade gets crowded, the stocks get bid up, and these pricier assets generate lower returns overall as a result.
Of course, just because a board is more diverse ("diversity takes time, but inclusion can be immediate" as some people like to say regarding the DNI or Diversity aNd Inclusion movement), or a company is more socially responsible, there are no guarantees that the company generates better revenues. However, it does stand to reason that a company that takes good care of its stakeholders - suppliers, consumers, and the entire supply chain - as opposed to just the shareholders in the company - would better weather the inevitable storms that every business has to face. So then, is ESG investing more an attempt to protect the downside vs. capture the upside of various investments?
Litigation around environmental, social and governance (ESG) issues is on the rise, with both civil and criminal cases being heard by courts around the world. Such litigation poses not only financial risk but also reputational risk to the corporations involved. This trend therefore adds an additional layer of investment risk to companies with weak ESG metrics. -- Gregory Kunz, Head of Research, Pictet Asset Management (article)
When the last major financial crisis happened, there wasn't this much attention paid to the ESG movement, so we do not know how various firms weathered the volatility that resulted (rather, we can figure how they reacted to volatility during that period, but due to lack of ESG being mainstream, we cannot claim that the reaction factored in ESG aspects). However, people like to claim that in 2020 with Covid, corporates with higher (better) ESG scores outperformed the competition. There are research papers that indicate that it wasn't that environmentally aware companies did better but that the less environmentally friendly sectors were badly impacted due to stay-at-home restrictions and business closures. Lower demand for oil due to slowing growth is not necessarily an ESG driven theme, though perhaps the gradual shift towards electric vehicles is. It helps if savvy investors look deeper to understand the various drivers that move stocks in various sectors, and use that as a basis for drawing conclusions as opposed to just picking a favorite cause and running with it.
A fascinating course on Coursera offered by Erasmus University called "Principles of Sustainable Finance" explores these and other ideas from both sides and presents what I think is a fair and balanced view of the topic, all while educating us on what Sustainable Investing really means. Worth the time.
We can try to save the planet (we live here after all), invest wisely, and make money while doing good. Everyone wins.
No comments:
Post a Comment