ESG investing, short for environmental, social, and corporate governance investing, has come a long way. Although historically investing, especially with public monies, has been done for a wide variety of reasons, ESG has only recently come to the forefront. In the early sixties and seventies, some pension funds started recognizing the power they had to bring good through their investment decisions. Later, in 2004, then UN Secretary General Kofi Annan wrote to the chief executive officers of fifty of the most influential financial institutions in the world inviting them to a joint discussion on what would become the first steps towards a global ESG movement.
From this initiative, a paper titled “Who Cares Wins” was published. The paper sought to connect the financial markets to the changing world by offering recommendations to better integrate ESG issues in analysis, asset management, and securities brokerage. The argument was that ESG factors, when incorporated into financial decisions, could lead to more sustainable markets and improved societal outcomes.
Another report by UNEP/Fi titled “Freshfield Report,” solidified the argument for ESG investing further by demonstrating the relevance of ESG factors in financial valuations. These events led to the establishment of the global ESG movement that we have today. With such a firm foundation set, what has led to the rise and rise of ESG investing?
Kevwe Yerifor is the chief investment officer at Capital Intell. Capital Intell is an investment firm focusing on the alternative investment asset class with a keen interest in private equity, real asset, and venture capital. Here, he explores the rise of ESG investing.
The Rise and Rise of ESG Investing
From the two reports published, the Principles for Responsible Investment (PRI) was established at the New York Stock Exchange in 2006 as well as the establishment of the Sustainable Stock Exchange Initiative (SSEI) in 2007. What these two initiatives did, says Kevwe Yerifor, was to offer a framework that financial institutions could use when engaging in ESG investments. However, a framework alone is not the primary reason why ESG investing is on the rise - it is as a result of other underlying trends. One major trend pushing ESG investing is climate change. A few decades ago, companies needed only to focus on simpler environmental issues like toxic waste disposal. Today, climate change is the elephant in the room. So, how is climate change impacting ESG investing?
Science and technological advancements are playing a crucial role in this development, says Kevwe Yerifor. As scientific proof pointing towards the impact of climate change mounts, economists are also demonstrating the multi-billion-dollar implications of negative climate change. As such, financial markets must pay attention to climate change because it now has a clear path of influence on market outcomes. Technology is playing a multipronged role in driving ESG investments.
First, big data and analytics are making it possible to better tie ESG factors, climate change among one of them, to financial outcomes. For instance, it is possible to run simulations of how climate change will affect investments over time. Secondly, technology has democratized markets, meaning investors (pension payers, for example) have greater visibility and transparency of what fund managers are doing with their money. In this way, they are demanding more responsible investing from their asset managers (pension funds, etc.).
Kevwe Yerifor says that while it may seem that all roads are leading to further ESG investments, there are important factors that are standing in the way of ubiquitous ESG investing.
Challenges Facing ESG Investing
ESG investing now accounts for about $20 trillion of total global assets under management. While this figure may be impressive, especially compared to a decade ago, this represents only just a quarter of all assets under management. Why aren’t more assets under the ESG investing category? Several factors are responsible for this, the biggest being an outdated argument. The argument goes thus: most fund managers believe ESG factors fall outside the scope of their fiduciary duties.
As their primary mandate is to maximize shareholder value, institutional investors have been shy to embrace ESG investing, seeing it as more of a nice to have than a need to have. However, such resistance cannot hold up in the face of investor pressure. A KPMG poll of C-suite executives found that 36% of respondents cited investor pressure as a key factor in their company’s increased focus on ESG investing.
Another barrier facing ESG investing, says Kevwe Yerifor, is lack of data and tools to collect, analyze, and interpret fragmented ESG investing issues. Most data falling under the scope of ESG factors is typically fragmented and difficult to collect and collate. For fund managers, this lack of cohesiveness makes EGS investing more of a liability than an asset. However, the launch of the Global Reporting Initiative (GRI) in 2000 has provided a useful reporting framework that makes it easier for financial institutions to navigate complex ESG reporting. Today, 80 percent of the world’s largest organizations use GRI standards.
What is Next for ESG Investing?
Issues like climate change, employee welfare, gender equality, and others are at the forefront of driving ESG investing. Over the next decade, anticipate seeing the emergence of more frameworks and initiatives that seek to strengthen the ESG movement further. However, ESG investing is still at the behest of senior executives and fund managers. For ESG to have meaning, it is essential for these parties to undertake ESG as a carefully calculated investment decision that brings all parties to the table. They can do so by following these guidelines, says Kevwe Yerifor:
- Focusing on business priorities as a base mark. ESG can incorporate a broad array of factors so companies can look for factors that align with stakeholder priorities while helping the business achieve its business objectives.
- Using a systematic and focused approach towards ESG investing. While top-down implementation through policies and principles can be a starting point, it should not end here. Leaders must work towards making a dual socio-economic case for ESG that earns them buy-in across the organization.
- Formulating and adopting an ESG matrix used when assessing new investments and used to align legacy investments through a gradual transition process.
Kevwe Yerifor’s Final Thoughts
In today’s rapidly evolving business and social environment, change and uncertainty are the only constants. Kevwe Yerifor believes that ESG serves as an economic moral compass that can help organizations train their sights on a future where business and social interests do not compete for scarce resources, but instead work in tandem for the betterment of humanity.