Making Cents: Your Guide to ESG Investing (Part 1)
IN the first of two articles, this week I will examine the rise of sustainable investing, which are investments that consider environmental, social and governance factors alongside financial factors when making decisions. investment.
And next week I’ll be posting a second post because you might want to consider implementing your own ESG investment strategy, which is why I’m going to look at specific ESG investments and give you 2 examples of mutual funds from ESG investment, 2 ESG ETFs and 4 ESG companies.
What exactly is ESG investing?
It is essentially an investment strategy that takes into account environmental, social and governance factors as well as financial factors when making investment decisions. It is part of “sustainable investment”.
Below is a breakdown of factors related to a company’s impact on the environment and society and the way a business is governed:
Environment (E): climate change, greenhouse gas emissions, recycling practices, water use, use of renewable energies, supply of raw materials, etc.
Social (S): employee health and safety, fair wages, employee training and development, ethical supply chain sourcing, data privacy and security, etc.
Governance (G): diversity of the board of directors, executive compensation, business ethics, transparency, political contributions, etc.
ESG investing has become increasingly popular with a report from the Forum for Sustainable and Responsible Investment suggesting that last year more than $ 17 trillion in assets under management were held in sustainable funds, this which represents about a third of all assets under management.
Thus, sustainable investing is not a new phenomenon, and it seems that they are taking over, depending on the volumes of new money invested in it. Investors are starting to take money out of traditional equity funds, those that don’t have a clear and obvious sustainability goal or that use environmental, social and governance measures, and put it into sustainable funds.
Green funds in particular, those that focus on the climate, the environment and renewable energies, are the most popular choices. Four of the top ten sustainable funds with the biggest inflows last year came from those focusing on renewables.
And the values of what are now called green stocks have, in some cases, been multiplied by three and even by four. Just look at the electric car maker, Tesla. At the same time last year they were trading at $ 162.26 and at the time of this writing they were at $ 625.22 which is an increase of 285%.
Last year some $ 50 billion was invested in sustainable funds, more than double what was invested the year before.
And there are very good reasons why this is happening.
In 2017, a study by Morgan Stanley Capital International (MSCI) found that companies with higher ESG scores were associated with higher profitability, tail risk, and lower systematic risk.
In 2019, the International Monetary Fund (IMF) released a report suggesting that when investors create investment portfolios that prioritize ESG stocks, returns are not sacrificed.
In February 2020, the European Securities and Markets Authority (ESMA) released a Trends, Risks and Vulnerability report that examined ESG investments. It also reviewed the performance of the EURO STOXX ESG Leaders 50 index with its corresponding benchmark, the EURO STOXX 50. And over a two-year period from 2017 to 2019, the EURO STOXX ESG Leaders 50 was the big winner.
And in March 2020, Bloomberg reported that 59% of US ESG ETFs outperformed the S&P 500 index and 60% of European ESG ETFs beat the MSCI Europe index in the first quarter. However, it was also noted that six of the ten largest US ESG-focused mutual funds performed worse than the S&P 500 during the same time period. It is therefore important to note that ESG investments do not outperform at all levels.
It is quite telling that some leading investment management firms are now focusing their investment strategies on ESG. For example, BlackRock, the world’s largest asset manager, announced in January 2020 that it would reorient its strategy towards investments related to climate change issues.
This means that the integration of ESG into investment strategies has developed with momentum. And MSCI, cited three main reasons for this growth:
New challenges: Problems such as sea level rise and personal data leaks, for example, are more common these days and introduce new risks for investors. Therefore, an investor can evaluate investment strategies based on these new risks.
New Investors: There is a new generation of investors who don’t just look at the bottom line of their investments. Interest is growing in strategies that comply with ESG standards.
Availability of data and analytics: There is more research and business data about ESG that investors can use to make their decisions.
ESG rating models
With its growing popularity, data providers have created scoring criteria on which they can rank ESG investments, enabling socially responsible investors to make informed decisions when choosing companies, ETFs or mutual funds. .
Companies like MSCI, Standard & Poors and Blackrock have developed their own ESG rating models.
The world’s largest index provider, MSCI, for example, has a rating system in which it ranks companies on an “AAA to CCC” scale and, based on a company’s rating, it is classified as late, middle or leader.
The parameters they use to determine environmental ratings take into account such things as a company’s contribution to climate change, pollution and waste management, the use of green technologies and renewable energies. . And under social, they examine health security and human capital development, product and consumer safety, community relations and under governance, they assess corporate governance and fairness and accountability and transparency and ethics.
Companies are assigned a score from zero to ten in each area, with zero indicating virtually no exposure and ten indicating very very high exposure to a particular ESG risk. The scores are then aggregated, weighted and scaled according to the relevant industry sector to arrive at a letter-based rating, which is very similar to what credit ratings use for banks and countries.
A score between 8.5 and 10 will receive an AAA designation and will be considered a leader. Between 7.143 and 8.4 the letter score is AA and between 5.7 and 7.142 is A.
Letter ratings that attract a BB or BBB rating are considered average and B and CCC ratings are considered lagging behind, meaning they are lagging behind their industry and are highly exposed to failing. manage significant ESG risks.
Tesla, for example, has an MSCI ESG rating of A, which sits at the bottom of the rankings.
It excels in corporate governance and environmental risks (it has a relatively low carbon footprint) and invests heavily in green technologies. It would get a higher rating if it wasn’t for the quality and safety of the product (exploding batteries, poor crash text ratings, and crashes involving their car’s autopilot function), but what really has a impact on his grade is his work management practices. He was found to be breaking labor laws for blocking unionization and came under severe criticism for keeping factories open during C19 as several of his workers fell ill.
Okay, next week I’ll be posting a second follow-up post where I’ll look at specific ESG investments and give you these 2 examples of ESG mutual funds, 2 ESG ETFs, and 4 ESG companies.
Liam Croke is Managing Director of Harmonics Financial Ltd, based in Plassey. He can be contacted at email@example.com or www.harmonics.ie