Three whales. Why ESG investments are rapidly taking over the world

More and more investors are trying to use a responsible approach when choosing companies and their securities. These are the so-called ESG criteria. They allow a careful selection of corporations that adhere to the principles of sustainable development. Today, about 20 trillion US dollars are managed precisely taking into account the ESG principle, and this figure will grow.

Good companies

There are many examples of successful corporations around the world that are guided by the principles of ESG. According to financial publication Barron's, in the United States, the top five are consumer and digital appliance retailer Best Buy, high-tech Cisco, medical and instrumentation manufacturer Agilent Technologies, IT giant HP, and electronics manufacturer Texas Instruments.

Many Russian companies also claim to adhere to ESG principles. In 2018, the RAEX rating agency named the leaders of responsible domestic business that are effectively coping with environmental, social and governance issues. They were Lukoil, MMK, Gazprom, Tatneft and Alrosa.

Responsible approach

The abbreviation ESG is made up of the first letters of the words environmental, social and governance. These are three factors that are taken into account when investing in a company – environmental, social and managerial.

E-factors:   

• climate change due to company activities
• greenhouse gas emissions
• waste production
• depletion of natural resources, including drinking water
• reduction in forest area.

S-factors:

• working conditions, including the use of children as workers
• gender composition of the company
• health protection at the enterprise
• relationships with consumers and local communities
• contact with suppliers.

G-factors:

• long-term strategy of the company
• audit and internal control
• composition of the board of directors
• management remuneration
• shareholder rights.

Taking into account these factors allows the fund involved in ESG investments to make an informed decision on investing in the securities of a particular company. In general, this means that the corporations selected using this filter conduct socially oriented business, are distinguished by high-quality management and concern for the environment.

At the end of 2018, another study from EY appeared on the relationship between non-financial information (and this is just ESG) and investment decision making. It reached over 200 investors around the world.

“In the past few years, there has been growing evidence of the impact of trade on climate change. We have also witnessed scandals related to poor corporate governance. In addition, a new understanding of the impact of business on society is emerging. Institutional investors are increasingly using non-financial indicators as an important component of investment decision making," the authors of the study write.

The corporations selected using this filter are socially oriented businesses, distinguished by high-quality management and care for the environment.

According to EY, 97% of investors conduct either an informal assessment of ESG performance or a structured and methodical analysis of non-financial corporate data. Over the year, the indicator grew by almost 20 percentage points: previously, the share of such investors was 78%. It is noteworthy that at the end of 2018, only 3% of respondents reported that they were not interested in ESG factors at all. In 2017, they were 22%, in 2015 – 48%.

Criterias of choice

Evaluation and study of companies that implement the principles of ESG are carried out by specialized funds. For example, from February 14, 2019, the Swedish multi-share fund Alfred Berg Ryssland, which is under the advice of TKB Investment Partners (JSC), began to use the ESG filter in its strategy.

It is the first multi-bond fund in the world to take a socially responsible approach to investing. In other words, when a specific decision is made to invest in shares, Alfred Berg Ryssland evaluates companies from the Russian Federation in terms of ESG criteria.

It is important for the fund's clients to know that the company's environmental, social and governance performance is taken into account when selecting shares, emphasizes Anita Lindberg, responsible for ESG at Alfred Berg. The fund's specialists collect all the necessary information directly from companies, use estimates from third-party organizations, and also consult with the TKB Investment Partners team. As a result, all issuers that did not pass through the ESG filter are simply eliminated.

There are cases when dissatisfied shareholders put pressure on management, forcing the company to behave responsibly.

But the ESG principle is used not only at the stage of selecting securities of a particular organization. Recently, these criteria have become a guide to action when making strategic decisions. There are cases when dissatisfied shareholders put pressure on management, forcing the company to responsible behavior. In the fall of 2017, Australia's largest bank, the Commonwealth Bank of Australia (CBA), became the first financial institution in the world whose shareholders filed a lawsuit over insufficient disclosure of information on the impact of climate change on the company's operations.

The fact is that the CBA financed the Carmichael coal project. The use of coal in energy is a sore subject for Australia. The country is moving away from this resource towards clean energy, and the society, including the holders of securities, makes sure that the investment policy is in line with the environmental one. As a result, the CBA announced a full exit from investments in coal projects.

The Australian energy giant AGL did the same – coal-fired power plants will cease to function by 2022, instead the company will use the energy of the sun, wind and water. “We do not consider the development of coal generation economically rational,” AGL explained its decision. After that, the Australian media wrote that it was no longer possible to invest in coal. According to Influence Map, the country's coal industry has lost hundreds of billions of dollars of investment in recent years.

Such a policy is aimed not only at protecting the environment and animal rights, it provides an opportunity to significantly reduce costs

ESG is gradually moving from an ethical to an economic plane. Take the example of clothing manufacturers. Fashion houses Gucci, Michael Kors, Jimmy Choo and Armani have abandoned the use of natural fur and switched to synthetic materials. Shoe manufacturer Nike is reducing the use of natural leather, replacing it with recycled Fly Leather.

Such a policy is not only aimed at protecting the environment and animal rights, it provides an opportunity to significantly reduce costs. It takes 15 times less energy to produce a single faux fur coat than a captive-bred fur coat. Moreover, artificial materials, as a rule, are much easier to process and give designers more opportunities to choose colors and textures. In turn, the production of shoes from Fly Leather allows you to reduce water costs by 90%. In addition, non-natural components do not require careful transportation and special storage conditions.

Percentage of responsibility

Of course, the use of an ESG filter does not allow one to hope for fabulous profits. This approach to investing is aimed at long-term sustainable performance and can be considered conservative. In particular, the global ESG index of developed countries over the past 10 years has shown a yield of 11.5% against 45.2% for MSCI World.

Yet responsible investment is in demand. In 2017, British Schroders polled 22,000 investors around the world. Nearly 80% of them reported that investing in sustainable companies is more important to them than they were five years ago.

In January 2019, the American company BlackRock published the results of a survey of its customers. These are approximately 230 structures that manage more than seven trillion US dollars – public and private pension funds, insurance companies, charitable organizations. More than half of respondents (51%) said they were going to review their investment strategy. Nearly a third (27%) of the investors surveyed spoke about the growing importance of the ESG principle in decision making. Most often, BlackRock customers from EMEA countries – Europe, the Middle East and Africa – spoke about this.

It turned out that since 2014 there has been a positive relationship between responsible investing and the return on securities

Given the growing interest in the ESG segment, the use of these principles is beginning to positively affect the effectiveness of investments. Thus, the French investment company Amundi (1.3 trillion euros under management) carefully studied the profitability of portfolios based on ESG factors. The analysis included shares of 1.7 thousand global companies for the period from January 2010 to December 2017. It turned out that since 2014 there has been a positive relationship between responsible investing and the return on securities.

Thus, in the European market, the return on buying 20% ​​of shares of companies with a high ESG rating and selling 20% ​​of securities with a low rating gave 6.6% per annum in the period from 2014 to 2017. A similar strategy applied in 2010-2013 would show a loss of 1.2%. The US market has slightly different figures: +3.3% and -2.7%, respectively.

Investment Etiquette

A responsible approach to investing has been known to mankind for several centuries. Ethical investments became the prototype of the ESG approach. Often their use is associated with various religious movements. For example, back in the 17th century, the Quaker Protestant community forbade its members from conducting financial transactions related to slavery. In the Islamic world, it is forbidden to invest in companies or projects related to the production of alcohol or gambling. Another example is the work of the Church of England Foundation (assets – about 16 billion US dollars). This structure does not invest in the production of weapons, cigarettes, alcohol and pornography for ethical reasons. Norway's $1 trillion sovereign wealth fund does not invest in companies dealing with nuclear weapons, tobacco products, or coal.   

According to the General Director of TKB Investment Partners (JSC) Vladimir Kirillov, ESG is becoming a more significant factor for international investors. And funds whose investment process is built around ESG are actively gaining popularity. Kirillov notes that today in the world more than 20 trillion US dollars are managed using the ESG principle – this is a quarter of all assets in trust management.

Thus, investing with ESG in mind is not just a fashion trend or a momentary desire to please public opinion. A company that conducts business responsibly is most often managed with an eye to strategic forward development. So, it can serve as a reliable object for investment.