Creating value in the economy through ESG investing

Social cohesion and good governance will help accelerate any country’s post-crisis recovery.

ESG investing can be thought of as “doing well by doing good”. ESG strategies provide superior long-term financial performance whilst promoting a greater good. For example, the world’s largest fund manager, BlackRock, wrote an open letter this year saying that “sustainability- and climate-integrated portfolios can provide better risk-adjusted returns to investors.” That is to say: over time, more virtue equals more money.

I’m too embarrassed to ask – What is ESG?

ESG (Environmental, Social and Governance) causes can be strong environmental standards, such as sustainable natural materials, water conservation and carbon dioxide reductions. They can be advancing social issues, such as diversity in workforce and leadership, human rights or poverty reduction. They can also revolve around ethical corporate governance measures, such as anti-corruption and capped executive compensation. Covid-19 has spearheaded ESG centric values as everyone has noticed decreased pollution, leading to more sustainable funds or at least ESG-integrated funds under many asset managers including BlackRock, Vanguard and Fidelity. This motion from prominent institutions in turn stems confidence in consumers and allows for a shift of interest.

How does ESG investing create value then?

A strong ESG proposition links to value creation in the economy in some major ways. Firstly, there would be greater top-line growth. Lack of sustainable products would mean that there would be a loss of customers through poor sustainability practices (e.g. human rights, supply chain).  There could also be a loss of access to resources as a result of poor community and labour relations.

Secondly, there would be a reduction in costs. For example, the use of circular economy models would mean that unnecessary waste would not be generated. Thirdly, regulatory and legal interventions would be minimized. This would mean that there would be greater strategic freedom through deregulation. This would help earn government subsidies and government support. Fourthly, this would increase employee productivity and attract talent through greater social credibility. Lastly, this would also optimise investment and capital expenditures as we are avoiding investments that may not pay off because of longer-term environmental issues.

I’m too embarrassed to ask – What is a circular economy?

A circular economy is an alternative to a traditional linear economy (make, use, dispose of) in which we keep resources in use for as long as possible, extract the maximum value from them whilst in use, then recover and regenerate products and materials at the end of each service life. 

There have been significant advancements in sustainable investments in the last decades that every asset class has evolved to include financial products and investment strategies that incorporate sustainability factors. Major index providers (i.e. MCSI, S&P, FTSE) are already offering indices with sustainability considerations. Examples are the MSCI ASWI Sustainable Index, S&P ESG Index etc.

Upcoming economic recovery, an ESG recovery? 

ESG will play a role in rebuilding the post COVID-19 world. Increased investment in the renewable sector would help create jobs in the economy. Social cohesion and good governance will help accelerate any country’s post-crisis recovery. The consequences of weak ESG factors in some emerging economies have been seen during the pandemic. Countries that were less prepared for the health crisis due to a weaker health care system and less developed infrastructure, and/or less prepared for an economic crisis due to fiscal imbalances, high levels of debt and external dependencies have suffered greater damage. By contrast, countries that were in a stronger fundamental shape before the crisis, with stronger institutions, lower levels of debt and more diversified economies have fared better. Widening income inequality in many countries also remains a critical issue that threatens to undermine economic stability and intensify social discord. Damaged economies and elevated employment from the pandemic have only worsened several pre-existing structural problems.

Countries that effectively address these challenges in the years ahead can strengthen the underpinnings of their economies, whilst those that neglect these factors risk further instability. In this manner, it can be seen that ESG could be a defining attribute for global fixed income markets in the years ahead. 

However, increased ESG investing does come with its own set of risks. Special risks associated with investing in foreign securities are those associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies. Sovereign debt securities are subject to all of the risks of foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt. Investments in emerging market countries are subject to all of the risks of foreign investing generally and have additionally heightened risks due to a lack of established legal, political, business and social frameworks to support securities markets.