In early 2005, when Kofi Anan, the Secretary-General of the United Nations, invited a group of leaders from the international investment community to develop a set of global best-practice principles for responsible investment. Anan’s asked the CEOs was to create a mechanism for the integration of environmental, social, and governance (ESG) factors into business decision-making. The collective effort of the private sector and UN culminated in the launch of Principles for Responsible Investing (PRI) at the New York Stock Exchange in April 2006.
In many ways, this was the starting point for the ESG movement, which entails reviewing companies on environmental, social, and governance parameters and investing in them accordingly.
Around the same time, UN Global Compact published “Who Cares Win” The primary contention of the report was simple, better investment leads to more sustainable societies. And this set in motion the wheels of ESG revolution that has become an undeniable force. With all the hullabaloo around climate change, the consequences, and the mitigation, investors are now giving priority to companies that staunchly adhere to the triple bottom line principle, namely People, Planet & Profit.
The strength of the movement can be gauged by the amount of money that is flowing in the name of ESG investment. According to estimates, global sustainable investments peaked at over $30 Trillion in 2018 after a 34% climb over the preceding two years. As of June 2019, there were estimated to be nearly 2,900 ESG-linked funds globally with about $890 billion in assets under management, with the bulk of the funds domiciled in Europe, and the US, according to data compiled by Morningstar. In India, we see similar moves being made. There are mutual funds that are promoting ESG-led investment, like Avendus, Quantum, and SBI Mutual Fund.
Beyond the purview of the institutional space, many investors are actively promoting the uptake of ESG principals. The passion related to ethical investment can sometimes turn into an obsession; for instance, Sir Chris Horn set up The Children’s Investment (TCI) Fund Management, a London-based hedge fund management firm in 2003 that invests in companies that have robust governance and environmental practices. Over the past many years, TCI has taken a strident position in support of ethical, environmental practices.
One could argue that the environment and other social issues have little or no bearing on the financial performance of the company. Yet numerous studies have irrevocably inter-linked the success of the corporation with ESG principles. The companies that are most like to exist for many years are the ones that will embrace ESG in different degrees. Good governance practices will always help build resilience with the company to withstand the changing market dynamics.
According to a Morningstar report, funds that took ESG factors into account in their investments have performed better than their non-ESG funds. In five cases out six, the more ethical fund outperformed its more traditional alternative over one and three years, the firm said. This means that being ethical is not merely about being right, but also being profitable.
So, what are the factors that are driving the ESG uptake?
The factors that are driving the change can be broadly classified under four heads:
Real World dynamics: the global challenges like climate change, flood risks are forcing companies to review their systems for business continuity.
Investor push: new-age investors who are concerned about the planet and wish to drive positive changes through their investment. A KPMG study found that more than one-third of company executives surveyed said that pressure from investors had increased their company’s focus on ESG.
Increased transparency: with digitization and automation, there is a whole data and analytics piece that has come into play. Companies can use systematic, quantitative objective and financially relevant approaches to ESG mainstreaming.
Compliance and risk: governments across the world are putting in structures and rules to ensure that the international commitments on climate change are met.
The rising awareness can be gauged by the fact that Afsaneh Beschloss, CEO of The Rock Creek Group and Clifton Robbins, CEO of Blue Harbour Group, advised investors about the importance of ESG in their portfolios. Blue Harbour reportedly managed more than $3 billion in assets through 2017. Rock Creek reportedly managed over $12 billion.
And it is not only in terms of investment. ESG can also be used as a way to punish, through disinvestment. TCI Fund, in the past, has used this tool to drive its agenda. Recently, Pharo Management, a UK-based hedge fund, returned $300 million to the Saudi Arabian Monetary Authority after the murder of journalist Jamal Khashoggi at the hands of the Saudi government, according to Bloomberg News.
Back in December 2017, six sovereign wealth funds came together to create the One Planet Sovereign Wealth Fund Working Group. It’s objective: to develop an ESG framework to address climate change and encourage sustainable growth and market outcomes.
In the ESG is driving companies towards better governance and sustainability practices. Integrating ESG within the business can be a greater opportunity to prepare for the future world. There are numerous mechanisms that can available and can used from GRI to PRI or even TCFD or SBTi. Aligning business with ESG principles should not be merely seen as a checkpoint or a challenge, but a mechanism to future-proof the enterprise.
The earlier it is done, it is better.