Introduction to ESG Flashcards
What is ESG Investing?
- Approach to manage assets
- Considering and pricing environmental, social and governance (ESG) factors in investment decisions
- Along with own role as owner and creditors
- Long-term return of investment portfolio in mind
Environmental Factors
• Factors pertaining to the natural world
• The use of and interaction with renewable and non-renewable resources
• Such as water, minerals, ecosystems, and biodiversity
• Examples:
o Climate change
o Resource depletion
o Waste
Corporate social responsibility (CSR)
• Broad concept describing company’s approach to ethical business
• 20th century: philanthropic – now around behaviour can play role in business model
• Strategy changes led to triple bottom line (three P’s)
o People
o Planet
o Profit
Responsible investment
• Strategy to incorporate ESG factors into investments and active ownership
• Considers how ESG impacts:
o Risk adjusted returns
o Stability of an economy
o Engagement with assets impact society and environment
Socially responsible investment (SRI)
• Approaches that apply social and environmental criteria in evaluating companies
• Score companies:
o Chosen set of criteria
o Sector specific weightings
• Hurdle set for qualification based on full universe or sector
• First screen for ESG companies, used with:
o Best-in-class investment
o Thematic funds
o High-conviction funds
o Quantitative strategies
Best-in-class investment
• Score companies and overcome hurdle:
o Chosen set of criteria
o Sector specific weightings
• All-sector approach means good for maintaining a characteristic in an index
• (?) Security selection seeks to maintain regional and sectorial diversification and a similar profile to the parent market cap index, while targeting companies with higher ESG rating
Sustainable investment
• Select assets that contribute to sustainable economy
• Can be used for consideration of
o ESG issues
o Best-in-class issues
o ESG integration – securities risk and return profile
• Used to describe those that benefit macro-trends
• Can also screen out certain activities such as coal mining
Thematic investment
• Selecting companies related to sustainability related theme
• Clean-tech, sustainable agriculture, healthcare, climate change
• Fund picks companies in various sectors related to theme
• Not all thematic funds are responsible investments as must
o Be related to theme (and)
o Have ESG characteristics
• A smart city fund invests in
o EVs
o Public transport
o Renewable energy
o Green buildings
Green investment
• Capital for assets that mitigate environmental challenges o Climate change o Biodiversity • Examples include o Low-carbon generation o Pollution control o Recycling and waste management o Process innovations • Considered sub-category of thematic or impact • Example: green bonds
Social investment
• Capital for assets that address social challenges
• Can be BOP
o BOP: Bottom of the Pyramid
o Refers to the poorest two-thirds (4 billion people)
o Alleviate poverty while providing growth for businesses serving these communities
• Examples
o Micro-finance
o Basic telecommunications
o Energy access
• Example: social impact bonds – public sector contract – better social outcomes – passes saving to investor
Impact investment
• Specific intent of generation social and environmental impact alongside financial return
• Usually direct investments:
o Private debt
o Private equity
o Real estate
• Range of returns – below-market to market - The Global Impact Investing Network (GIIN) estimates the size of the global impact investing market to be US$502 billion (£393bn); its 2019 annual survey indicated that 66% of investors in impact investing pursue competitive, market-rate returns.
• Invests in companies that
o Offer basic services
o Provide availability of low carbon energy
• Measurement and tracking usually at heart of investment
Ethical/value-driven and faith-based investment
• Usually negative screening avoiding morally objectionable investments ‘sin stocks’ by
o Religion
o International declarations
o Conventions
• Typically include: tobacco, alcohol, pornography, weapons, breaches in Universal declaration of Human Rights
• Catholic ‘sin stocks’
o Facilitate abortion, contraceptives, weapons
• Shariah
o Firms that profit from alcohol, pornography, or gambling
o Carry heavy debt loans and pay interest
o Own investments that pay interest
o Invest in pork-related businesses
Why Integrate ESG?
• Reduce risk and enhance returns – forward-looking insights into the investment process
• Leads to
o Reduced cost and increased efficiency
o Reduced risk of fines
o Reduced externalities
o Improved adaptability to sustainability megatrends
Sustainability megatrends
i. Emerging and urban
- Economic activity in emerging markets – industrial and urban revolutions simultaneously
- 97 % of Fortune Global 500 in developed – will be half by 2025
- Half of GDP between 2010 and 2025 – 440 cities in emerging markets
- Impact: supply chains, workforces, local communities
ii. Technological disruption
- Accelerated adoption of technology leading to accelerated innovation
- Social media becoming new social fabric
- AI – perform tasks that would usually require human intelligence
- Health industry – track patients’ data and medication
- One-third of jobs can be replaced by smart machines
iii. Demographic changes and wealth inequality
- 2030 – world’s population is set to increase by 1 bn
- Increased elderly population – China labour force peaked in 2012
- Rethink economy potential – need for caring for elderly
- Increased population – 35 % more food by 2030, increased energy use
- Concentration of wealth increasing social strains
iv. Climate change and resource scarcity
• Average temperature increase more than 2 C – irreversible environmental damage
• Reduced water availability in Africa
• Agricultural sector:
o Alter growing conditions and seasons
o Increased pest and disease
o Decrease crop yields
• Challenging to predict future disruption – unpriced and could be internalised such as commodity price
• Pacific Gas and Electric Company (PG&E), a listed American utility, was driven to bankruptcy proceedings due to wildfire liabilities. The company’s equipment led to more than 1,500 fires between 2014 and 2017.
Putting ESG into practice
Three ways
o Incorporating ESG factors into investment decisions
o Corporate engagement
o Policy engagement
i. Investment decisions
• Support from investment consultants – factor in ESG policy, implementation and outcomes into selection process
• Use investment mandates and monitoring processes
• Embed ESG to strategic asset allocation (SAA) – SAA is the process an investor uses to allocate capital across asset classes based on return, income and risk appetite
• In security selection
o Apply filter or threshold
o Integrating ESG with financial or risk analysis
o Using ESG criteria for thematic approach
ii. Shareholder engagement
- In AGM by formally expressing view via voting
- With investment firm, individually or collective discussion
iii. Policy engagement
• Work with regulators to design system that is o More stable o Levels playing field o Brings ESG to financial decision making • Investors can o Respond to policy consultations o Collective initiatives o Recommend to policy makers
