Investors have traditionally focused on their investment returns while giving little or no attention to how these returns are generated, or the risk they carry. However, this is changing and there is now a growing opinion that the concept of responsible investing is a driver of financial value. With investors becoming socially conscious, organizations are responding by integrating Environmental, Social and Governance (ESG) factors – in varying degrees – to operate responsibly and improve long-term outcomes.
Record amounts of investment capital have been committed to Sustainable Investing. The industry is expected to grow to USD160 trillion of total global assets by 2036. This resolve is building corresponding momentum in actual investment in sustainable solutions and the resultant benefits, regardless of whether the goal is to ‘impact-invest’ or simply end up with more attractive returns.
Sustainable Investing involves deploying capital in a targeted manner into assets managed with Environmental, Social and Governance (ESG) considerations. Incorporating an ESG strategy does not negate profit making rather the objective is to effectively manage risks while positively responding to environmental and social issues.
Strong evidence exists to support the notion that improved ESG standards creates stronger governance in the organization’s structure and processes. From an investor perspective, this stronger Governance means that you can obtain the same return with less risk, as well as achieve a positive impact on the environment and society.
Here is how it works
Fund Managers utilize a wide range of ESG integration strategies in the bid to enhance investment returns, such as exclusion screening, thematic investing, impact investing, investee engagement or a combination of one or more. For example, in exclusion screening, an investor may choose to avoid companies (or investments) that are perceived as unethical such as alcohol, tobacco and gambling. A major downside of this approach is potentially eliminating financially profitable businesses.
Funds Managers with an impact investing strategy, may seek to invest in companies proffering solutions to climate change – resilience, mitigation, and adaptation.
Other approaches incorporate ESG as an additional factor within a broader decision-making process or involve actively working with companies to improve their sustainability performance and in turn, positively impact bottom-line.
The good news for investors who want to ensure their investments have a positive, sustainable impact, is that they can achieve this goal via ESG strategies without sacrificing investment returns. Evidence suggests that incorporating sustainability factors leads to improved risk management, partly because ESG-compliant firms face lower costs of capital (i.e., a lower cost of borrowing in bond or equity markets) and a low risk premium due to greater transparency and compliance with rules and regulation.
For an ESG-focused investor, this means that even if returns with or without sustainable investing factors are similar, it can be achieved with the former taking less risk.
The evidence on whether an ESG-based investment strategy leads to outperformance relative to a global equities benchmark is mixed. While many studies argue there is substantive evidence that adding responsible investing criteria can lead to better investment returns over time, this is often sensitive to whether the ESG criteria are used to simply screen out investments that do not meet their conditions, or whether they are used as an additional factor as part of a broader investment process. Where the evidence appears more compelling is that incorporating ‘sustainability’ as a criterion appears to support improved corporate performance in specific parts of the market, such as bonds, real estate, and emerging market equities.
Sustainable investing does not come without risks, as active exclusion of ‘excluded’ sectors may limit investment performance. However, we believe the positive aspects of Sustainable Investing far outweigh the risks. There has been a significant growth in investments in ESG over the past few years, it is estimated that $120bn flowed into sustainable investments in 2021, a significant increase on the figure of $51bn for 2020. Clearly, a huge number of investors share our sentiments…
Lanre Olajide is the Head of Wealth Management Nigeria and West Africa at Standard Chartered Bank.
