What is ESG?

Three letters have become vital to investors over the last few years: E, S and G. But what do they stand for and why are they so important? How do they affect overall portfolio returns? Can they be easily analysed? What trends are likely to affect them?

Here we take a look at these ‘Environmental, Social and Governance’ factors that companies and fund managers must consider.

What is ESG?

ESG is a short snappy way to describe ‘Environmental, Social and Governance’ factors that are faced by an organisation.

These issues – which can be both positive and negative – include everything from a company’s carbon emissions to its gender diversity.

According to Rob Sharps, president and chief executive of T.Rowe Price, these elements can impact the “sustainability and long-term success” of businesses.

“Identifying, analysing, and integrating information about ESG risks and opportunities help enhance our ability to make better investment decisions and pursue better outcomes for our investors,” he said.

Confusion in this area

However, it’s also worth pointing out there can be confusion as to what actually constitutes ESG, according to Rahab Paracha, sustainable multi-asset investment specialist at Rathbones.

“This isn’t surprising given the lack of consistency in the language used by asset managers, regulators and the media on the topic,” she said.

That’s why it’s important that you understand exactly how a fund defines ESG and which elements it prioritises before deciding whether it meets your needs.

ESG in fund research

Unsurprisingly, fund managers have become increasingly focused on ESG factors when analysing prospective holdings in their portfolios.

It’s something we at FundCalibre focus on heavily in our fund analysis. Every Elite Rated portfolio will have been analysed on the basis of its approach to ESG.

We highlight what aspects are particularly important to the fund manager and how the team helps ensure holdings meet their requirements.

To keep things simple, we assess each fund as either ESG Explicit, ESG Integrated or ESG Limited. You can find out more here.

Let’s now take a more detailed look at what each of the letters – E, S and G – covers.

Environmental

Environmental is commonly associated with ethical investing and focuses on the environmental impact of how a business operates.

This means it will include issues relating to carbon emissions, energy efficiency, electronic waste, the use of packaging materials, clean technologies, and green buildings.

Social

This is a pretty broad area that covers everything from labour stands to public health measures, as well as safety, privacy, and responsible investment.

Social issues being discussed will include gender diversity, privacy and data protection, community relations, and customer satisfaction.

Governance

The final part is used to focus on the standards contributing to how a company is run. This helps to build up an overall picture of management’s attitude.

Factors will include board composition, executive pay, lobbying and political contributions, as well as whether whistleblower schemes are in place.

Why are ESG factors important?

Companies are no longer judged on financial performance alone. A wide variety of issues are now considered by customers and investors. Executives must demonstrate that their company is reputable, responsible, trustworthy, and run in a way that doesn’t adversely affect the environment.

Social media has certainly played a part in the rise of ESG. Reputations can be destroyed overnight should a post about a company ‘go viral’ on the internet. Even badly sourced allegations – or even the merest whiff of a past scandal – can be enough to wipe millions of pounds from a company’s valuation.

Sustainability reports

Companies increasingly publish sustainability reports that demonstrate to shareholders – and potential investors – their approach to ESG. This enables them to be very open and transparent about the risks and opportunities they face and how they are tackling them.

It comes as investors and other stakeholders are calling on businesses to disclose more about such strategies, according to a report from PwC. “Sustainability report is an ideal and effective means of enabling companies to answer in a single document a wide variety of questions that stakeholders may raise,” it stated.

The future for sustainable investing

Sustainable investing is expected to become more important over the coming years due to increasing legislation and a desire to safeguard the planet.

However, while there’s a growing appetite for investing in a more sustainable future, these vehicles are coming under more scrutiny, according to JPMorgan’s ESG Outlook 2023. “There is no doubt that sustainable investing is here to stay, but the question is what it will look like after a decade long bull market, attacks from anti- movements, and greenwashing allegations,” it stated.

Getting exposure to ESG

Many investors will benefit from the increased focus on ESG factors because most fund managers will now take them into account during stock selection.

In fact, investment houses will make it clear if a fund manager is keen on a particular ESG element and wants this to play out in their fund.

However, investors that want enhanced exposure to ESG areas now have plenty of specialist funds from which to choose. For example, there are portfolios that identify growth trends that are likely to shape the future global economy, then buy companies that are expected to benefit.

There are also funds that focus on businesses improving water quality, as well as those investing in companies that are coming up with innovative solutions to combat climate change.

You can research all the Elite Rated Responsible Investment funds here.

_{Photo by Casey Horner at Unsplash}