The Rise of ESG

Several large banks and fund houses are realising that their definition of what is financially relevant needs to involve environmental, social and governance (ESG) factors. These issues are now becoming critical in investment decision-making. Investors are incorporating these to reduce risk and seize opportunities by fine-tuning equity exposures, searching for excess returns, remaking bond portfolios and tapping the green bond market. ESG represents about one-quarter of all professionally managed assets around the world.

In 2020 the momentum has grown as the pandemic has highlighted the importance of responsible, environmentally friendly growth. Further, there are increasing demands for a green recovery the world over. Customers have also become more informed and have started actively looking for sustainable products and companies that treat their stakeholders well. At the same time, investors are increasingly investing in ESG funds and the volumes of these funds have skyrocketed. It has been shown that companies that rank high on ESG provide higher returns and tend to have lower cost of capital.

Environment: Focuses on a company’s environmental disclosure, environmental impact, and, any efforts to reduce pollution or carbon emissions

Social: Refers to creating societal wellbeing either in the worlplace or in society at large. It includes diverse concepts such as diversity, human rights, philanthropy and corporate citizenship.

Governance: Accounts for compensation, shareholder rights, and the relationship between shareholders and management

The practice of ESG investing began in the 1960s as socially responsible investing (SRI), with investors initially excluding stocks or entire industries from their portfolios based on their involvement in business activities, such as tobacco production or their implicit support of the South African apartheid regime.

While ethical considerations and alignment with values remain common motivations of many of today’s ESG investors, the field is rapidly growing and evolving. For asset owners who seek to invest in a way that is aware of and responsive to climate change, solutions in the marketplace have traditionally focused on mitigation: reducing the effects of climate change on a portfolio by, for example, reducing exposure to greenhouse gases and increasing exposure to ‘green’ energy companies. As extreme weather events become more frequent and the economic impacts of climate change more widely understood and accepted, investors will require companies to disclose how they are adapting their business strategies to accommodate the impacts of climate change.

Many investors now look to incorporate ESG factors into the investment process alongside traditional financial analysis. As part of this process, investment firms gather ESG data on companies and use this to make decisions on valuation and risk that a stock poses. With investors looking at ESG as a value-based dimension of their portfolio, they increasingly want to understand ESG performance in the same way they would any other traditional financial measure. This, is leading to greater interest in robust ESG reporting along dimensions such as carbon intensity, controversy exposure, and overall ESG profile.

Once considered a niche market for institutional clients with specialised investment needs, ESG investing has gone mainstream. It now spans multiple asset classes and is used by a diverse group of investors. We have tracked ESG over the seven years of our study and it indicates that companies are putting significant efforts to improve their performance.

ESG Performance Over Years

ESG Performance Over Years



Our ESG analysis looks at various factors to capture ESG components:

Environment

Focuses on a company’s environmental disclosure, environmental impact, and, any efforts to reduce pollution or carbon emissions

Climate ChangeNatural CapitalPollutionOpportunity
GHG disclosureWater mappingProcess waste, including waste water dischargeOpportunities in Renewable energy
Air emissionsWater managementPlastic wasteOpportunities in Green buildings/factories
Responsible finance*Responsible sourcingPackaging wasteOpportunities in Sustainable product/service
Electronic wasteOpportunities in Employee awareness
Organic/food wasteOpportunities in Green logistics

Social

Refers to creating societal wellbeing either in the worlplace or in society at large. It includes diverse concepts such as diversity, human rights, philanthropy and corporate citizenship.

Human CapitalCustomerSocial Opportunities
Employee managementHealth & SafetyOpportunities in community welfare
Employee welfareEnvironmentOpportunities in Employee management
Health & SafetySocialOpportunities in Supply chain management
Human Capital developmentFinancial Literacy
Supply chain labour standardsResponsible Advertising
CSR Volunteering

Governance

Accounts for compensation, shareholder rights, and the relationship between shareholders and management

Corporate GovernanceCorporate PoliciesDisclosure
Board committeesCustomer data privacyResponsible business reporting framework
Executive ManagementBiodiversity policyExternal assurance
Alignment with principles/frameworks like SDGsResponsible business policyImpact assessment
Employee policiesMaterial issues
Partnerships/Collaborations