esg: A sustainable future for investing?

Chris Howard – Financial Planner – 24th June 2020

The coronavirus pandemic has transformed our world and as we all reflect on our own mortality and social responsibilities, there is a strong argument to reshape our investment strategies accordingly, argues Chris Howard.

Some of the changes Covid-19 brought with it – from an appreciation for cleaner air and reduced traffic, to increased admiration for frontline health and service workers – will have been welcomed by all.  However, in other areas the impact of the virus has been immensely negative. It has taken away our freedom to travel, as well as exposed our vulnerabilities, not only as individuals but as a society.

The UK lockdown has meant that the majority of our everyday lives has been forced to operate from home.  Some companies have found this to be hugely beneficial. Netflix and Zoom are just two examples of companies who have outperformed other shares in the past few months. For others however, mainly retailers and airline companies, the pandemic has caused share prices to plummet, and revenues to dry up overnight.  

This pandemic could prove a major turning point in the way many look to invest monies; altering not only society’s values but our moral responsibilities. When it comes to benefiting future generations, be it through trusts or estate planning, this responsibility becomes more important. The demand to “do something good” becomes an important factor we shouldn’t ignore. Therefore, a focus on the companies that we invest in, in terms of their impact on society and the world, is likely to become more predominant.  Something that lends itself well to these values, is ESG.

ESG(Environmental, Social, Governance) is a coined phrase used in capital markets and by investors to evaluate the behaviour of companies, as well as determining their future financial performance. The ESG factors are a subset of non-financial performance indicators, exploring the ethical, social and corporate government morals companies hold. These categories can be covered in the following ways:

With growing interest in ESG criteria, investors need a way to objectively assess the ESG performance of a company. This has led to a growth in ESG Rating Agencies – Sustainalytics, MSCI, and FTSE ESG to name a few – who assess companies globally on their ESG performance.

These ratings are designed to help investors identify the ESG risks of a business. Companies are evaluated based on publicly available information, with scores given for each subject (‘E’, ‘S’ and ‘G’), alongside an overall score.

Investors then use these unique scores as a representation of a company’s ESG performance. Those that score well are believed to better foresee future risks and opportunities, be more prepared with longer-term strategic thinking, and stay focused on long-term value creation

This ideology seems to have been proven correct over recent months, with ESG portfolios tending to outperform traditional portfolios. But why is this the case? Perhaps because ESG funds tend to lack exposure to oil companies, which have been hit hard by the lack of demand and by the pricing war between Saudi Arabia and Russia.

However there is a possible, more important consideration, in that outperformance; Governance. This is always going to be a major factor when considering the sustainability of operations of a company. Better-governed companies tend to be of a higher standard and boast stronger management, in turn making them more resilient to unexpected, or potential downturn.  

Because of the pandemic and the recent outperformance, an increased awareness in ESG is certainly evident from individuals, and many may start to question what ESG characteristics their investment portfolios show.  With the FCA confirming that financial advice firms will need to consider their clients’ ESG preferences when assessing their objectives, and in the context of product classification, this awareness is only going to grow.

This new interest may bring an increasing pressure on the financial industry to evaluate a company’s environmental, social and governance ratings, alongside the traditional financial metrics considered. Within the legal profession, ESG investing is likely to become a future discussion point, be it through reviews of existing Investment Policy Statements or investing new monies. An awareness of the subject matter will be needed. The back-up of trusted investment advisers will also be important, to be able to review and advise on this type of investment strategy. This will ensure that trustees and beneficiaries are sure they are investing not only in line with their “moral compass”, but also maximising potential returns.

This blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions and should be considered as guidance and not advice. It is important for all individuals examining their investments and pensions to seek expert financial advice from a regulated financial adviser. Solicitors should be cautious when examining pensions and investments (especially Trust investments) with their clients as it is easy to stray into the area of regulated financial advice. None of the information contained in the Blog constitutes a recommendation that any particular strategy is suitable for any specific person.

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