Those who ignore ESG trend could lose out on millennial boom
Environmental, social and governance (ESG) investing has arguably reached a point where it is too important for investors to ignore. This type of investing is about using these three important criteria as factors to make investment decisions.
It is being driven by a shift in attitudes towards a desire for returns that benefit society as well as financial returns. Think emission reductions, workforce diversity, workforce training and development, board structures, management compensation policy, shareholder rights and business ethics for some of the more obvious examples. ESG investing goes well beyond socially responsible investing, which simply excludes stocks or sectors from portfolios because of undesirable activities or products. ESG applies to all sectors, and screens companies that may score positively or negatively on its metrics.
To understand why interest in ESG has grown since the financial crash of 10 years ago, it's interesting to observe that, in the US during the pre-crash years, some of the largest banks would have seen a marked deterioration in their social and governance factors, linked to issues like employment quality, shareholder rights and management compensation policies. Those that went bust would have been rated the worst, particularly for compensation. Ireland would not have been dissimilar. There were some high-profile calls for less financial regulation here around the same time - and executive remuneration in banking was high too. In these cases at least, you could argue that an investor using an ESG approach to invest back then may well have avoided some of the disasters that followed.
Yet there is scepticism about the value of ESG to the investment process. Can it really lead to meaningful returns? As with most things in investing, the answer is not black and white. Views differ on what qualifies as ESG characteristics, and so rating providers use different indicators and methodologies. But there is evidence that ESG investing is possible without hitting performance. So, those who desire societal and financial returns really can have their cake and eat it.
The size of the investor base set to integrate ESG into their investment practices seems set to grow over the coming years. Europe already has a strong track record in values-based investing, helped by EU non-financial reporting directives. However, it is in the US where the potential for ESG investing is greatest. Moreover, it is thought that when the transfer of wealth from baby boomers to millennials starts around the late 2020s, trillions of dollars could flow into ESG investments. That would be consistent with surveys of millennial attitudes to investing.
There are many challenges in integrating ESG factors into investment strategies. Company reporting with respect to ESG issues is inconsistent, as is the interpretation of any such data. Significant knowledge of a sector is required. For example, a high-growth company may not score well on governance factors, but that doesn't necessarily mean it's a bad investment. It could be at a stage of its life cycle that requires greater focus on sales than board structures. No easy task then. Still, it seems that those investors who ignore this ESG trend do so at their peril.
- Brian Flavin is senior equity research analyst with Goodbody (goodbody.ie)
Any investment commentary in this column is from the author directly and should not be seen as a recommendation from The Sunday Independent
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