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Responsible Investment – Beyond Financial Returns

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Responsible Investment – Beyond Financial Returns
Responsible Investment – Beyond Financial Returns

Responsible investments have gained popularity in recent years, alongside the increasing global government and corporate actions on environmental, social, and governance (ESG) issues. The trend to pay attention to ESG in investment risk assessment and strategic decision making is undeniably evident and becoming more mainstream. However, do we really understand what this involves? This article seeks to introduce and explain responsible investment, why it matters, and what to expect in the near future.


What is Responsible Investment?

According to the United Nations Principles for Responsible Investment (UN PRI), responsible investment is a strategy and practice that incorporates ESG factors in investment decisions and active ownership. This is complementary to traditional financial analysis and portfolio construction techniques.


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The table above illustrates the investing spectrum ranging from pure financial returns to solely social returns depending on investment focus and return expectation. Responsible and sustainable investments focus on the long-term value of a firm based on its ability to mitigate ESG risks and identify growth opportunities.

PRI also discussed many ways in which investors can invest responsibly, from incorporating ESG issues as they build a portfolio through integration, screening, and thematic investing, to advocating for more sustainable business practices in companies that they have already invested in. Similarly, there are many stages of responsible investing, ranging from ESG incorporation to active stewardship.


Why does ESG matter?

The world of responsible investing is growing rapidly, reshaping how people live and invest. As such, it is crucial to understand the motives behind the change and how investment portfolios will be affected by these changes. There are three main factors driving the growth of sustainable investing, specifically materiality, client demand, and regulation.

Materiality

Recognition that ESG factors are able to affect risk and return is burgeoning amongst investors. As a result, it is important to integrate financially material ESG issues into investment analysis and decisions to better manage risk and improve returns. The materiality of an ESG issue will differ between investors depending on the issues that align with their values. For instance, an investor passionate about social injustice will place a higher materiality on firms that engage in sweatshop labor as compared to an investor who cares about climate change.

Examples of financially material ESG incidents in recent years include:

  • The Deepwater Horizon oil spill in 2010 – BP Plc paid a pre-tax charge of US$53.8 billion to account for the damage done by the oil spill. The company’s shares dropped 54% as a result of the incident.
  • In 2015, Volkswagen’s share price plunged over 30% after the firm was exposed of having rigged their diesel vehicles in order to pass emissions tests.
  • Over US$100bn was wiped off Facebook’s market value in the wake of the Cambridge Analytica scandal when personal data was harvested from Facebook without users' consent in 2018.

Client Demands

High-profile cases such as those above heightened a level of caution and attention to the impact of ESG on valuation and market performance. Investors are leaning toward investments with strong ESG factors and sustainable business strategies. According to a Bloomberg report, ESG-focused investment funds experienced an inflow of US$347 billion, with more than 700 new funds being launched globally in 2020. With a growing awareness that ESG factors affect a firm’s value and returns, coupled with a heavier focus on ESG impacts on a firm, investors are progressively calling for greater transparency on sustainable business practices and reporting.

Regulation

Policymakers around the world are making ESG disclosures and sustainability reporting a legislative priority. The European Commission has adopted a comprehensive package of measures to help improve the flow of money toward sustainable activities across the European Union. The United Nations Climate Change Conference (COP26) in November is expected to introduce new global regulatory changes, as well as industry-level initiatives. In Singapore, the Monetary Authority of Singapore (MAS) has published the ‘Guidelines on Environmental Risk Management for Asset Managers’ report, outlining their expectations of fund managers’ approach in managing and disclosing environmental risk.


Trends in Responsible Investments

1. Shift in Focus

A new set of ESG lens is now being used for investment analysis as responsible investments gain traction. Nevertheless, there is still a notion that responsible investing would mean having to sacrifice financial returns for environmental and social impact. However, research conducted by Morgan Stanley has determined that there is no financial trade-off in the returns of ESG funds. With growing awareness of responsible investing, investors will recognize that they are able to gain long-term financial returns and create environmental and social impact at the same time.

2. New Generation of Investors

The Gen X, millennial and Gen Z generations tend to be more socially and environmentally conscious than the older generations. According to Morgan Stanley’s Institute for Sustainable Investing, 86% of millennials are interested in generating positive environmental and social impact through their investments. Moreover, these generations are likely to receive the wealth passed down by their parents, making it the largest intergenerational wealth transfer in history, estimated to be more than $30 trillion. With the capital in hand, coupled with their interest to grow their wealth through responsible investments, it is expected that the market for responsible investment can only grow in value and importance.

3. COVID-19 Pandemic

According to S&P Global Market Intelligence’s analysis, multiple ESG funds outperformed the S&P 500 during the COVID-19 pandemic as there was an acceleration of capital towards companies that were more prepared to address climate risk. This highlights not only ESG funds’ potential for profit but also resilience against risk events. With an increasing percentage of investors tilting their investment portfolios towards companies that seek to address ESG issues, the tectonic shift towards sustainable investments will only continue to accelerate further.


Key Takeaways

  • Responsible investing shows no slowing down to date. ESG rating frameworks are increasingly being used to identify and measure the sustainability and performance of firms.
  • Regulatory bodies are working to provide standards for ESG disclosures. However, there is the risk of greenwashing whereby firms may make misleading ESG declarations. Investors are advised to conduct due diligence when embarking on responsible investments.
  • Though responsible investments have progressed rapidly in recent years, there is still much room for growth as retail and institutional investors, asset owners and fund managers continue to embrace the adoption of ESG for their investment strategies.

If you are interested to know more about Responsible Investment, please feel free to contact Singapore Consultancy. Our group of consultants has a rich and diverse experience that can provide guidance in this area regardless of the stage you are at in your ESG journey. Reach out to us today for a non-obligatory discussion. We look forward to hearing from you.

A sustainable future is a shared responsibility.


References:

https://www.unpri.org/an-introduction-to-responsible-investment/what-is-responsible-investment/4780.article

https://www.cfainstitute.org/en/research/esg-investing

https://www.unpri.org/download?ac=325

https://www.bloomberg.com/news/articles/2021-02-10/the-490-billion-boom-in-esg-shows-no-signs-of-slowing-green-insight

https://www.mas.gov.sg/regulation/guidelines/guidelines-on-environmental-risk-management-for-asset-managers

https://www.mse.gov.sg/policies/overview/

https://www.morganstanley.com/content/dam/msdotcom/ideas/sustainable-investing-offers-financial-performance-lowered-risk/Sustainable_Reality_Analyzing_Risk_and_Returns_of_Sustainable_Funds.pdf

https://www.morganstanley.com/access/why-millennial-investors-are-different

https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/esg-funds-beat-out-s-p-500-in-1st-year-of-covid-19-how-1-fund-shot-to-the-top-63224550

https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf

Posted by DENISE QUEK