The Rise of ESG Investing
Investors used to make investments in companies based on financial performance. In the recent years, increasingly they look beyond profits and prefer investing in companies that align with their principles and values.
So… What Exactly is ESG?
ESG stands for Environmental, Social and Governance. The integration of ESG factors into investment policies, processes and practices helps measure the sustainability and ethicality of a company.
Environmental (E) includes climate risks and pollution.
Social (S) includes human capital issues and work place conditions.
Governance (G) includes business ethics and tax transparency.
Simply put, a socially responsible investor will decide to invest in a company based on ESG factors and steer clear of low ESG scoring companies. We believe that ESG factors will help investors assess the overall quality of a company and their financial performance in relation to the changing social and environmental issues.
Table 1: ESG Issues
| Environmental | Social | Governance |
|---|---|---|
| Climate change and carbon emissions | Customer satisfaction | Board composition |
| Air and water pollution | Data protection and privacy | Audit committee structure |
| Biodiversity | Gender and diversity | Bribery and corruption |
| Deforestation | Employee engagement | Executive compensation |
| Energy efficiency | Community relations | Lobbying |
| Waste management | Human rights | Political contributions |
| Water scarcity | Labour standards | Whistle-blower schemes |
Source: CFA Constitute, ESG Issues in Investing (2015)
Take for example, you may not consider investing in the tobacco industry because you have family or friends who developed illnesses due to smoking. In this scenario, you would probably want to invest your money in other industries.
Many investors realise that ESG investing helps to build a more sustainable future and mitigate some of the risks arising from climate change.
According to the 2015 Nielsen Global Corporate Sustainability Report, 66% of global consumers say they are willing to pay more for sustainable brands. How about Singapore? Well, a whopping 80% of Singaporeans stated that they are willing to pay a premium for products that contain environmentally friendly or sustainable materials.
Today, ESG is no longer just another fad, it has become mainstream and forms a core part of investment portfolios.
Creating Value with ESG Factors
“Can I invest responsibly and make money, too?”
In reality, many investors remain skeptical about ESG investing as they believe that it may result in loss of some returns. However, many studies have shown and recognised sustainable investing as a driver of long-term investment performance.
The MSCI ACWI ESG Leaders Index, MSCI Europe ESG Leaders and MSCI EM ESG Leaders, which provide exposure to companies with high ESG performance relative to their sector peers, generated better returns when compared with MSCI ACWI, MSCI Europe and MSCI EM for the period of Sep 2017 to Jan 2020. Thus, it is worth noting that integration of ESG factors into the investment portfolio may potentially enhance portfolio returns.
Chart 1: Cumulative Gross Returns (USD) of MSCI ACWI ESG Leaders and MSCI ACWI (Sep 2007 – Jan 2020)
Source: MSCI ACWI ESG Leaders Factsheet, 31 Jan 2020
Chart 2: Cumulative Gross Returns (USD) of MSCI Europe ESG Leaders and MSCI Europe (Sep 2007 – Jan 2020)
Source: MSCI Europe ESG Leaders Factsheet, 31 Jan 2020
Chart 3: Cumulative Gross Returns (USD) of MSCI EM ESG Leaders and MSCI EM (Sep 2007 – Jan 2020)
Source: MSCI EM ESG Leaders Factsheet, 31 Jan 2020
Strong Momentum Behind the ESG Investing Wave
We found that investors have been putting in more money in ESG funds last year.
According to independent research company Morningstar, ESG mutual funds and exchange-traded funds saw a net inflow of $20.6 billion in 2019, which is almost four times higher than 2018.
Chart 4: Sustainable Funds Estimated Annual Flows
Source: Morningstar Article, “Sustainable Fund Flows in 2019 Smash Previous Records”, 10 Jan 2020
An Aspirational Set of Investment Principles
The Principles for Responsible Investing (PRI) is the world’s leading proponent of responsible investment. The UN-supported PRI is an international network of investors working together to put the Six Principles into practice. By joining PRI, investors are committed to incorporate ESG factors into their investments and ownership decisions.
Today, PRI has a total of 2,372 signatories, with a total Asset Under Management (AUM) of USD 86 trillion. The largest asset owners at the PRI by AUM are based in Japan, France, Germany and Austria.
Chart 5: PRI’s Number of Signatories and AUM
Source: PRI Website, Data as of April 2019
Chart 6: AUM by Geography
Source: PRI Twitter, 28 Jan 2020
Beyond ESG
ESG factors not only help assess the competitiveness of a company, but also help investors avoid companies that engage in “irresponsible” activities. Investors mindful of these ESG factors may avoid investing in companies engaged environmentally unfriendly acts such as the BP’s oil spill disaster, Tokyo Electric Power Company’s Fukushima Daiichi nuclear disaster and Volkswagen’s emissions scandal.
Becoming a Better Investor
ESG investing plays an integral role in portfolio construction, risk management and performance attribution. This is accompanied by an increase in interest in companies that care about climate change.
“If we could produce better portfolio returns while being socially responsible, why not?”
If you want to ride on the wave of sustainable investing, investing in mutual funds is one of the most cost-effective ways to build a diverse ESG portfolio as fund houses will help to screen responsible companies according to ESG considerations.
Explore ESG Funds on POEMS!
Currently, we have 15 ESG-themed mutual funds on POEMS for investors who are seeking sustainable investment solutions. So, do check out the links below:
Disclaimer:
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This editorial has not been reviewed by the Monetary Authority of Singapore.
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