The term ESG was first coined in 2005, as part of a study called ‘Who Cares Wins’, which brought together many parties from the financial services sector to explore the role played by Environmental, Social and Governance (ESG) issues in the long-term investment decision-making process.
The growth in investment in this space over the last 5 years has been remarkable, and 2020 has only accelerated this. From the devastating bushfires in Australia, to a cyclone in India and Bangladesh, the recent events in the United States surrounding the election, and of course the global pandemic which has shaken the world, Covid-19, many are looking to change their overall investment approach.
A report carried out by Morningstar in July 2020 found that the global inflow of capital into sustainable funds had increased by 72%, which was largely dominated by European investors. At the end of June 2020, the quantum of assets within sustainable funds reached a record high of US$1.062 trillion, which was an increase of 23% on the previous quarter. A report completed by Standard Chartered also revealed that approximately 40% of investors in Singapore will be looking to allocate 5 – 15% of their portfolios to sustainable investments over the next 3 years.
Clearly sustainable investing is here to stay, and isn’t simply a fad that will disappear. In fact, we expect that ESG measures will become the accepted norm, and will no longer be the differentiating factor over the years to come, which is a positive step forward as we progress to cleaner and more sustainable business practices.
Larry Fink, CEO or Blackrock, published a note to company Chief Executive Officers (CEOs) in 2017 highlighting the following: “Generating sustainable returns over time requires a sharper focus not only on governance, but also on environmental and social factors facing companies. BlackRock has been undertaking a multi-year effort to integrate ESG considerations into our investment processes, and we expect companies to have strategies to manage these issues.”
This week, I’m exploring what ESG investing is, what are the pros and cons that are involved as well as what impact this may have to your overall returns.
First, let’s start with what ESG investing is.
ESG investing refers to taking into consideration the environmental, social and governance factors of a company or particular investment when making the investment decision. This typically includes factors that are not usually considered part of the financial analyses, but may still have a profound impact on the long-term financial success of the company. This could include factors such as:
- Treatment of their workforce and global supply chain
- What the corporate culture of the company demonstrates
- How the company is responding to climate change
- Equal opportunity employment across the company and its board
- Energy efficiency of the company
- Overall impact on the wildlife surrounding the company’s operations
In simple terms, ESG investing focuses on selecting those companies that have a positive impact, or a less negative impact relative to alternatives on the environment, current social issues and corporate governance.
How is ESG investing actually carried out?
Investing in those companies that meet the ESG criteria is typically carried out in one of two ways. The first of these is called Negative Screening, in which those companies that have a relatively low, or poor, ESG scores would be avoided. This would typically include sectors such as gambling, tobacco or arms dealing. We would typically see those companies removed that have been convicted of environmental or workforce violations.
The second method is what is called Positive Screening, which is more proactive, in which those companies that are actively trying to do good in the areas covered by ESG are included in the investment mix. There is no right or wrong approach in terms of which method is better, and in many cases a combination of both can be sensible.
Does ESG investing improve long-term investment performance?
Given the recent growth in ESG investing as a style, and number of new funds and investment options, this is a difficult question to answer until there is more data available. However, many studies have confirmed that those companies that are meeting and complying with ESG criteria will typically have a lower cost of capital as well as improved operational performance. This is driven by a wide range of factors, many of which will come as no surprise to most:
- Improved staff morale leading to greater production output
- Lower-cost financing options available
- Government grants and incentives made available
- More positive PR and marketing opportunities as a result of the company’s actions
- Reduced possibility of fines and breach notifications
Based on the existing data, it is likely that those companies that are meeting the ESG criteria will likely perform well over time, which to date has certainly been the case. It is important to highlight here, however, that past performance does not indicate future performance, and you should consider your own risk profile, situation and objectives before investing in anything.
How do I invest in ESG investments?
There are many options when it comes to investing in the ESG space, and as always, I would recommend that you seek professional advice to consider your options and which may be right for you. You may wish to invest through a Managed Fund, via an Exchange Traded Fund (ETF) which I’m personally a fan of, or even through individual companies.
I have outlined some of the fund and ETF options below for your reference:
- Betashares Global Sustainability Leaders ETF
- Betashares Australian Sustainability Leaders ETF
- Vanguard ESG US Stocks ETF
- Invesco Solar ETF
- iShares Global Clean Energy ETF
- Australian Ethical Diversified Shares Fund
- Alphinity Sustainable Share Fund
If you have any questions about what ESG investments may be suitable for you, or would simply like to check how much exposure you have to ESG-compliant or non-compliant companies, please feel free to reach out to me and book in a complimentary appointment to review your options.
To Your Financial Success!
Jarrad Brown is an Australian-trained and qualified Fee-Based Financial Planner with Australian Expatriate Group of Global Financial Consultants Pte Ltd providing specialist financial advice and portfolio management services to Australian professionals in Singapore. Jarrad Brown is an Authorised Representative of Global Financial Consultants Pte Ltd – No: 200305462G | MAS License No: FA100035-3
Australian Expatriate Group is a division of Global Financial Consultants in Singapore providing specialist advice to Australians living abroad.
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General Information Only: The information on this site is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision.
*Please note that Jarrad Brown is not a tax agent or accountant and none of the content outlined here should be taken as personal advice. You should consult your tax agent and financial adviser to review your current personal finances and financial goals to consider whether this strategy is appropriate for you.