How ESG is transforming investing outcomes

The global pandemic served, amongst other things, to accelerate some trends and put others to rest. One of the bright lights was the positive momentum built around acknowledging the risks of climate change and the need to move to sustainable investing.

There is now a renewed urgency for the world to work together to reverse climate change damage and move to a net-zero economy (keeping the average global temperature increase below 2ºC).

Kingsley Williams, Chief Investment Officer at Satrix, says, “While you may not immediately be able to replace your fossil-fuel-using car or take your home off the grid, there are opportunities in the investment world to encourage companies to start making the changes necessary to align with these global goals. And arguably ‘encouraging’ global capitalism to make these shifts will have a far greater impact than anything one individual can do – although we should never stop trying.”

Williams says that the decision to put your money to good work is easy. Knowing where and how to do it in a sea of jargon, misinformation and myths makes it a lot harder. Here, he unpacks a subsection of sustainable investing by focusing particularly on environmental, social and governance (ESG) aspects.

ESG vs Sustainability

Sustainability has become a catch-all phrase for ‘doing good’ and investing responsibly. Under this umbrella sits ESG, which specifically focuses on how environmental, social and governance impact a company’s operational efficiency and future strategic direction.

What is ESG?

“An acronym we use too easily, ESG stands for environmental, social and governance metrics as they pertain to good investment practices. These concepts, employed as metrics to measure how effectively companies incorporate the principles, have gained popularity over the past few years. Covid-19 has seen these practices accelerate.

“Harvesting data which relates to ESG allows investors to measure intangible ESG corporate initiative and risks, which increasingly have an impact on areas such as brand value and reputation. They are measures to see how companies are progressing to improve their initiatives in managing risks in these specific areas.

“Environmental metrics cover themes such as climate risks, natural resources scarcity, pollution and waste, and environmental opportunities. Social metrics include labour issues and product liability, risks such as data security, and stakeholder opposition. And governance encompasses items relating to corporate governance and behaviour such as board quality, diversity and effectiveness.”

Why invest in ESG funds

Williams says that incorporating sustainability issues into the investment research, portfolio construction, portfolio review, and stewardship processes provides different lenses on business risks. “This helps to mitigate further risks and potentially enhances long-term risk-adjusted returns and portfolio resilience. Even before the Covid-19 crisis, governments, businesses and investors were beginning to reassess certain personal and community values.

“It is possible to measure these values and intentions by incorporating ESG metrics into the investment process. Studies are now starting to reveal that companies that exhibit characteristics of resilience have focused on things like job satisfaction, the strength of customer relations, or the effectiveness of a company’s board.”

Why would you invest in ESG index strategies?

Recent innovations in the ESG index construction process take cognisance of the parent index from a risk perspective and aim to maximise exposure to higher-rated ESG companies within a tracking error risk budget e.g. the MSCI World ESG Enhanced Focus Index at 0.5% and 1.0% for the MSCI Emerging Markets ESG Enhanced Focus Index.

Williams says both indices are designed to maximise their exposure to positive ESG metrics while also explicitly reducing exposure to carbon dioxide (CO2) and other greenhouse gases (GHG) as well as their exposure to potential emissions risk of fossil fuel reserves by at least thirty percent (30%). The indices hold no weapons or tobacco companies, or companies involved in severe controversies.

He continues, “There are multiple ESG indices available, which each have different approaches to portfolio construction and what they try to achieve from an ESG and sustainability perspective. Investors looking to incorporate ESG into their portfolios but who are also concerned about the risk of deviating too far away from their ultimate broad-market benchmark may find a solution in the MSCI ESG Enhanced Focus indices.

He concludes that index investing in the ESG space is helping to educate and guide investors to predetermined outcomes with a greater sense of transparency and certainty. “Having audited methodologies and finite rules, at this stage, may give investors more comfort in the (perceived and real) risks they may be taking whilst they gain confidence in the ESG space.”

ENDS