Environmental, Social and Governance (ESG) investing is a strategy investors use to put their money to work with companies that strive to make the world a better place. It sounds like a great idea considering the numerous environmental and social issues that our society is facing: pandemics, racism, natural disasters, politically-driven terrorist attacks to name a few. Do you feel you have a good grasp of what’s behind ESG investing? For instance, do you know what its origins are? How is ESG measured? Or what can you do to ensure that your investment decisions resonate with your own values? These are three questions we would like to address in this CCS to provoke some thought and conversations.
What is ESG? And what are its origins?
The term ESG dates back to 2006 when it was first mentioned at the United Nations. However, we can track its roots to even before the 20th century. Originally, ESG was referred to as Socially Responsible Investing (SRI) to reflect the values of the times, mostly religious, that called for avoiding investments in “sin industries” (e.g., tobacco, gambling, alcohol). Moving forward to the 1960’s and 1970’s, civil rights, antiwar and environmental movements (e.g., Vietnam war, the apartheid, pollution) expanded the focus of what was considered socially responsible investing. As we become more aware of ESG issues, more people are deciding to use their investments as their way to do something about them.
In case you are wondering, here are some examples of what each component of ESG can entail:
- Environment: a company’s carbon footprint, toxic chemicals involved in its manufacturing processes, sustainability efforts that make up its supply chain, waste management, recycling, etc.
- Social: everything from LGBTQ+ equality, racial diversity across the various levels of the organization, inclusion programs, hiring and compensation practices, social advocacy programs beyond its sphere of business, etc.
- Governance: composition of the leadership of the company, its executive board and their operations and regulations.
ESG investments have grown almost exponentially in recent years. As of the end of March 2021, close to $2 trillion were invested in more than 4,500 sustainable funds globally, according to the Global and European Sustainable Fund Flows reports by Morningstar. The more money is invested, the more accountability for companies who have had to publicly report the outcomes of their sustainability strategies. And here we arrive at the measurement issue.
How are companies compared in relation to their ESG strategies?
A straightforward way of making those comparisons is by developing a ESG score. Specific firms take on that task. Bloomberg, S&P Dow Jones Indices, JUST Capital, MSCI and Refinitiv are a few of the most well-regarded ESG rating firms. Scores generally follow a 100-point scale: The higher the score, the better a company performs in fulfilling different ESG criteria. To come up with the score, ESG rating firms commonly review things like annual reports, corporate sustainability measures, resource/employee/financial management, board structure and compensation. However, the caveat here is that each of these firms may employ different metrics and weighting schemes, which means that a company may be identified as best-in-class by one firm and as average by another.
Say you are using two ESG rating firms: firm A and firm B to decide whether you want to invest in a particular company. In learning about their methodologies, you noticed that firm A gives more importance to the environmental aspects (60%) than the social (20%) and governance (20%) aspects, while firm B emphasizes social issues (50%) more than the other two (30%, 20%). If gender equality – one of the metrics used by these firms – is very important to you, then it might be possible that firm A will score your target company as average or even below average, while firm B would rate it highly.
So, if this scenario is a possibility, you are right in thinking that this is a very subjective mechanism, even when we are dealing with numbers. And you might be asking, what’s the point of the scores? And how can you use them productively? One way of thinking about it is that if a company is included in a ESG scoring list, it means that at least the company is willing to accept scrutiny on ESG issues. That information by itself could be a productive starting point in your decision-making. Some investment experts have suggested that ESG scores should be viewed as opinions. If they are to be taken up as opinions, there’s more work that needs to be done to provide objective clarity. You might need to do some research into the specific methodology, scores, and criteria that the ESG rating firm uses to decide whether their scoring system matches what’s important to you. Most of this information is already available in the ESG rating firms’ websites.
What could people do to tilt the odds that their personal ESG preferences are integrated in their everyday life, including investments?
In an effort to understand how much people care about ESG investing, BMO GAM in conjunction with DCIIA Retirement Center recently conducted a survey of over 2,000 people from the ages of 30 to 75 years old. They found that investors tend to group around 4 different ESG personas: ESG Motivated (22%), ESG Ready (30%), ESG Pragmatic (27%), and ESG Skeptical (21%). The difference among them is whether ESG is the lead topic (first two groups) or a secondary topic (last two groups) in their investment conversations with their advisors. This classification can be a helpful framework to consider your ESG positioning.
A few more questions to consider may be:
- What matters to you in life? Make a list from most important to least important
- What decisions in your life can have the most impact based on the above?
- Are you looking for an average representation of all three E, S and G? Or are you primarily concerned about specific areas? (e.g., global warming, controversial weapons, or human rights issues)
- What activities do you have available, locally, regionally, or nationally to promote those areas?
- If you incorporate those into your portfolio, what are you willing to give up?
Finally, based on these answers, is ESG investing really the path to doing your part as a socially responsible citizen of your local community, your country, and the world? If yes, go for it. If not, what else could you do?
If you are interested in some of the applications mentioned in this CCS, please see:
ESG Data, Ratings, and Investor Objectives. By Dimensional Fund Advisors, May 17, 2021 – available upon request.
https://www.newswire.ca/news-releases/bmo-global-asset-management-launches-myesg-tm-to-help-align-investments-and-beliefs-816373121.html The news release for MyESG tool.
Prepared by The Andrews Group in collaboration with Dr. Sayra M Cristancho, PhD., Scientist and Producer of the Research in 90sec’s podcast (listen in Apple Podcast or Spotify)
Assante Capital Management Ltd. Is a member of the Canadian Investor Protection Fund and is registered with the investment industry Regulatory Organization of Canada. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see a professional advisor for individual financial advice based on your personal circumstances.