The Rise of ESG Investing
By: Georg Kell, Chairman of Arabesque & Founding Director of the United Nations Global Compact
Responsible investing is widely understood as the integration of environmental, social and governance (ESG) factors into investment processes and decision-making. ESG factors cover a wide spectrum of issues that traditionally are not part of financial analysis, yet may have financial relevance. This might include how corporations respond to climate change, how good they are with water management, how effective their health and safety policies are in the protection against accidents, how they manage their supply chains, how they treat their workers and whether they have a corporate culture that builds trust and fosters innovation.
The idea that investors who integrate corporate environmental, social and governance risks can improve returns is now rapidly spreading across capital markets on all continents. In Europe, for example, a critical mass of pension funds and insurers have started to award new business exclusively to asset managers with ESG capabilities. The global investor community has developed a variety of methods for optimally integrating ESG information, such as outlined in A Practical Guide To ESG Integration for Equity Investing). Among the many ESG factors that are viewed as having financial relevance are especially those related to climate change. The reason for this is that climate change is no longer a distant threat on the horizon, but one that is here and now, with multi-billion-dollar economic consequences. Many investor initiatives are now pushing for de-carbonization and the Task Force on Climate-related Financial Disclosures (TCFD) has given much impetus for improving risk preparedness and, by implication, de-carbonization actions.
Cynics may argue that responsible investing is just a fad. But a closer look at the forces that have driven the movement over the past 15 years suggests otherwise. Firstly, technology and the rise of transparency are here to stay. Gathering and processing data will become ever easier and cheaper. Smart algorithms will increasingly allow for better interpretation of non-traditional financial information which seems to be doubling in volume every couple of years. Secondly, environmental changes, in particular climate change, will with scientific certainty put a growing premium on good stewardship and low carbon practices as natural assets will appreciate in value over time. And thirdly, people everywhere are increasingly empowered by technology. ESG investing allows them to express their own values and to ensure that their savings and investments reflect their preferences, without compromising on returns.
The rise of ESG investing can also be understood as a proxy for how markets and societies are changing and how concepts of valuation are adapting to these changes. The big challenge for most corporations is to adapt to a new environment that favors smarter, cleaner and healthier products and services, and to leave behind the dogmas of the industrial era when pollution was free, labor was just a cost factor and scale and scope was the dominant strategy. For investors, ESG data is increasingly important to identify those companies that are well positioned for the future and to avoid those which are likely to underperform or fail. For individuals, ESG investing offers the opportunity to vote with their money. And for policy makers, it should be a welcome market-led development that ensures that the common good does not get lost in short-term profit making at any cost.
Today, ESG investing has matured to the point where it can greatly accelerate market transformation for the better. As corporations and investors experience growing influence and power, their actions and decisions increasingly shape the future. Provided that political framework conditions based on openness and global rules do not deteriorate further, market-led changes will act as a force for good on a truly massive scale.
Originally posted on Forbes