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Environmental, Social and Governance (ESG)

Traditionally, the primary concern of investors has been the level of returns provided by an investment, with general ambivalence towards how those returns have been generated. Now, the industry is seeing a drive towards responsibility in its stewardship of investor money, with investors seeking to understand how their savings are being invested.


Ethical or responsible investing is not a new development, with many asset managers offering funds or investments under various guises; responsible, ethical, sustainable, socially conscious or impact investing are terms that you may have seen, almost interchangeably in many cases. A set of standards have developed in the industry to evaluate how companies operate in respect of the world around them, the people they deal with and whether they govern themselves in a responsible manner; these are termed ESG, for environmental, social and governance.


What does this mean?


Environmental - How a company interacts with its environment, so disposal of waste, use of energy, sustainability of resources, carbon footprint or compliance with environmental regulations.

Social - How a company interacts with people, whether that is staff, local communities or suppliers.

Governance - How a company is governed. This can mean rights of shareholders, avoiding conflicts of interest and making sure that the remuneration of directors is transparent.

ESG investing seeks to quantify and evaluate companies in these three categories, guiding investment into companies that are well governed and treat the world, their communities and staff in a responsible manner.


Fund managers are integrating these ESG criteria into their asset selection in varying degrees, with many managers building their entire research and selection process from the bottom-up to ensure that the companies in which they invest operate to these standards.


Further to the ESG criteria, there are a number of more targeted approaches that investment managers use as part of specific sustainable or responsible strategies. Here are some examples:


Thematic investing

Directed investment into specific themes, such as tackling climate change, transition of energy usage to sustainable sources or future water and food shortages.

Positive and negative screening

Positive screening is simply adding companies that exhibit responsible behaviour to a whitelisted universe in which to invest. Negative screening is the opposite, screening out companies that invest in unsustainable, controversial or unethical industries or exhibit poor ESG behaviour.

Impact investing

A strategy whereby investment is focused into responding to social or environmental needs and making a positive impact.

Activism

An investment manager with a strategy of activism will not necessarily stop investing in companies which do not fulfil ESG criteria, but will engage the board of directors to encourage change.

Investment managers may use some, or all, of the above as part of their ESG strategy.


There appears to be a growing opinion in the investment industry that companies that fit ESG criteria are well equipped to manage risk and operate in a sustainable manner in the future, so therefore are attractive investments in their own right. To this end, many investment managers are integrating ESG methodology into their investment processes from the ground up, rather than incorporating them into specific ethical or socially conscious strategies alone.


Traditional thinking on the necessity of giving up growth for ethical or responsible investing is also being reconsidered.


Many studies have highlighted that the investors of tomorrow will insist on positive impact as well as positive returns, so ESG methodology is now part of the mainstream and is here to stay.