Welcome to the final part of our series looking into ESG investing. Today, we take a look at aligning investment to sustainable development goals, the hidden problems with ESG investments and asking whether ESGs really are a ‘good’ investment.
In the second part of our series we took a look at what ESG means for global islands and the importance of ESG investing. If you missed this, click here.
Aligning investment to SDGs
ESG investing makes it much easier for investors to invest in businesses that are both ‘doing good in the world’ and avoiding harm.
It is encouraging to see that investment frameworks are becoming more strongly aligned with the United Nations Sustainable Development Goals (SDGs). The rapid and continuing growth of ESG investing will be vital for the successful realisation of the UN SDGs. This includes gender equality (Goal 5), affordable and clean energy (Goal 7), decent work and economic growth (Goal 8), responsible consumption and production (Goal 12) and climate action (Goal 13).
If business were to carry on as it has done until very recently, it would be almost impossible to achieve the majority of the SDGs by 2030. People and the planet’s resources were being exploited across the world in the name of profit. Greed was almost viewed as good, despite all the destruction it was causing. This isn’t to say that the profit motives of many business owners have gone away, but rather they are beginning to acknowledge the potential and benefits of a greener economic model. Now though, investors care about and can choose ESG investing, so many corporate leaders have no choice but to change. If they don’t, they risk facing a backlash from ethically-minded investors.
This is good news for those choosing an ESG investment strategy. As demand grows for products and services created by companies doing good, investors will achieve higher returns. According to the BNP Paribas ESG Global Survey 2019 “more than half (52%) of respondents rank improved long-term returns as the top reason for incorporating ESG in investment decisions, with 60% expecting their ESG portfolios to outperform over the next five years”.
Hidden problems within ESG investments
ESG investments are not without their issues. One of the major problems is that there are different ESG ratings agencies. There is not one standardised approach to ESG, but several methods of measurement.
As Investor’s Business Daily has pointed out, the variations in methodologies can cause a major problem. Between the four main ratings agencies, MSCI ESG, Sustainalytics, RepRisk, and ISS, they found major inconsistencies. They found that each of these agencies uses their own metrics, weighting, methodologies and even definition of what counts as ESG. The result of this is that “a company may rate well below its peers according to one ratings agency while simultaneously out performing them according to another” (Investor’s Business Daily, 2018).
This suggests that rather than being a trustworthy investment strategy for those who want to invest in companies doing good, it is a system riddled with pitfalls. If there is no one standard agency measurement, how can ESG investments be truly trusted?
An even bigger issue is the fact that ESG ratings agencies may be failing to take into account differing international standards. This is why, according to Investor’s Business Daily, both BMW and Volkswagen both received higher ESG ratings than Tesla from Sustainalytics. This is despite both BMW and Volkswagen being embroiled in separate major scandals. By contrast, Tesla manufactures electric vehicles, solar panels and energy storage, with CO2 reduction embedded in its business ethos.
These issues and others undermine the very purpose of ESG investing and their positive impact. Investors may be led to invest in certain companies because of ESG ratings, despite major negative aspects to their business model, such as faking emission reductions.
ESG investing could create the same problems for investors as ‘company greenwashing‘ does for consumers. They wish to do good but become confused by mixed messaging – the solution lies in more stringent monitoring, but also in ESG being more formally adopted within business structures, creating more competition and oversight.
Is ESG a ‘good’ investment?
Overall, despite the significant obstacles, ESG investing does appear to be generally positive. The growth in ESG investing has prompted company leaders to start to make changes that will please ethical investors. Ideally, this in turn means that the SDGs will become easier to achieve.
On the other hand, it is vital that the ESG investing framework is improved to become truly meaningful and effective. This will involve standardising the system to remove the subjectivity and disparities that exist. Otherwise, while not useless, it could become more of a superficial badge that companies display as good PR, while not resulting in meaningful change. If this becomes apparent to the public, they may be put off from trying to invest in companies doing good which would be a tremendous shame.
There is ample evidence that ESG investments are set to increasingly be the investment option of choice
For companies, incorporating positive ESG changes will become increasingly profitable in the long term, especially if investors have full confidence in the ratings system. There is ample evidence that due to the widespread international growth in ethical and environmental consciousness, that ESG investments are set to increasingly be the investment option of choice. From a business perspective, therefore, it makes perfect sense to make these positive alterations to attract more investors. If not, companies face a growing risk of losing to their competitors that do take into consideration the transition in public moral sentiment.
From the perspective of island stakeholders, the growth in ESG investing represents a potentially very positive shift. It will ideally mean that business leaders will start to enact a whole host of changes that will benefit island communities, leading to the possibility of more environmental sustainability and improved quality of life. This could include the transition away from single-use plastic, the move towards the widespread use of renewable energy and more equal gender and racial representation within company leadership roles.
As well as benefiting the lives of island residents, island business owners that incorporate ESG changes into their operations will also start to reap the benefits of increased investment.
You can catch-up with the Island Finance forum here, featuring…
- Moderator – Fiona Wilson, Senior Program Manager, Clinton Climate Initiative, Clinton Foundation Speakers:
- Jackie Marati, Senior Vice President/Chief Communications and Corporate Social Responsibility Officer, Bank of Guam
- Mark Lewis, Chief Sustainability Strategist, BNP Paribas Asset Management
- Steve Weinstein, Chair, Bermuda Business Development Agency (BDA); Former Chief Legal Officer, RenaissanceRe Holdings Ltd; Chair, RenaissanceRe Risk Sciences Foundation
- Simone Hudson, CFA, AVP Alternatives and Fund Management
Special report by courtesy of James Ellsmoor at Island Innovation. Written by Simon Turkas
