Why Invest in ESG? Does It Make Good Business Sense?
This article is courtesy of Andrea Zanon, an international financial, risk management and environmental advisor who partners with countries and leading corporation to help them stay competitive and resilient.
Responsible and sustainable investment results in better outputs and stronger financial returns for investors, communities, shareholders and the planet Earth. This is a key pillar for sustained, inclusive and equitable growth. Environmental, social and governance investing is a strategy everyone should employ to move towards a new value creation paradigm which makes the world a better place.
For me, ESG investing goes beyond a three-letter acronym to address how a company serves workers, communities, customers, shareholders and the global ecosystem. Over the last 10 years, ESG has rapidly become a top priority for management, boards and politicians, as it is perceived to be of key importance for long term competitive and inclusive success. According to McKinsey, over the last twenty years, ESG has expanded dramatically and “sustainable investment now tops $30 trillion—up 68 percent since 2014 and tenfold since 2004”.
What is happening in the stock market?
Over the last 24 months, ESG stocks have outperformed the market and have showed they can withstand bear market conditions. Furthermore, these companies are more resilient during periods of high risk and high market volatility such as the recent COVID-19 pandemic. To be more specific, while almost all stock prices corrected during the initial phase of the pandemic in early 2020, ESG traded companies performed well above the market. Through mid-March 66 per cent of ESG funds ranked in the top half of their categories and throughout 2021 they continued to show positive momentum particularly across cleaner energy, AI, and innovative financial technology focused on under-banked populations (people who do not have complete access to financial markets).
In addition, the increased intensifying of natural disasters, including floods, droughts, wild fire and extreme high temperature, is bringing renewed attention (particularly in the EU and in the US) to companies that have “vulnerability reduction approaches”, regardless of if those are social, environmental or governance. When assets and households are damaged, economic flows are interrupted and business continuity threatened, people start looking at risk mitigation options. This includes investing in resilience companies and teams (I define resilience as the ability of a company, city or system to absorb a shock, be it a natural or technological disaster, and bounce back rapidly and smartly).
I personally believe investment funds, hedge funds and family offices that embrace sustainability investment will significantly outperform the market and attract top talent. According to Goldman Sachs research, over 60 per cent of the younger generation is increasingly interested in investing in companies that take ESG seriously. Companies that focus more aggressively on adhering to ESG factors, have higher valuations than those that do not. As I advise young entrepreneurs in the Middle East and Africa, I know most of these brave leaders (particularly women) have a strong “mind and soul-set” and look at ESG as the only path to financial success, while helping society evolve and stay competitive.
Who Are ESG Investors and Leaders?
ESG investors are values-based investors who are more interested in what happens during the next decade than the next quarter. They are patient and know well financial results and meaningful impacts require more than a few years. Investors incorporating ESG into their portfolio tend to be the activist type and work closely with management to ensure that they are helping to build long-term value over a multi-year period.
Over a number of meetings and private interviews, I came across a recurring sentiment from ESG investors. They believe it is not essential to maximize financial returns, but rather ensure all companies are equipped with a “share value” approach. This is an approach spearheaded by Harvard Business School under the leadership of Prof. Michael Porter, where companies are partnering with government and NGOs to harvest the full benefits of social and environmental advancement (https://hbr.org/2016/10/the-ecosystem-of-shared-value).
Another incentive for ESG corporations, according to McKinsey, a leading international consulting firm, is operational cost reduction. In one of its recent studies (Getting your environmental, social, and governance proposition right links to higher value creation. Here’s why-McKinsey 2019), it explained those corporations that use ESG effectively can reduce operational expenses which could be affecting profits by as much as 60 per cent. McKinsey further elaborates that corporations with its boards should be measuring ESG metrics alongside other KPIs (key performance indicators) in order to streamline the process and create strong financial incentives to focus on ESG.
Based on the existing analysis, it is clear that ESG is a strong corporate value driver given the environmental, social and board pressure we are experiencing every day. Additionally, the perceived cost and risk of not acting on ESG is becoming hard not to address. In order to succeed in economic, societal, and environmental terms, we should use it in order to promote innovation and continue building a culture of open, inclusive and economic resilient growth across sectors.