Environmental Social Governance is growing in every geography around the globe. It’s in the headlines, high up on the agendas of corporations, and at the forefront of investor interest.
Even though it started to take shape in the 1960s, ESG has gained significant momentum in recent years, with 2020 standing out as a milestone year in this space. Adoption across the global asset management industry more than doubled, with total ESG funds growing more than 100 percent. And companies are now rally more ambitious ESG goals.
What’s driving the move from momentum to mainstream?
This is ESG Investing, Unpacked.
ESG Investing looks at an asset, like equities or bonds, through an Environmental, Social and Governance lens.
The goal is to determine whether the asset makes a positive impact. For example, fighting climate change or supporting safe working conditions. Governance is all about how a company balances stakeholder interests: How are decisions made? What processes are in place? Who benefits?
Here’s another way to think about it: The “E” and “S” are the end results. The “G” determines how these results are achieved.
This data helps investors make better-informed decisions.
The rise of ESG investing is based on a few points in history. Among them are the social movements against the Vietnam war and apartheid in South Africa, when companies faced divestments in opposition.
In 1981, the first major U.S. organization that advances responsible investing was founded: The U.S. Sustainable Investment Forum. And key events created global awareness of environmental issues.
In 2008, the Financial Crisis called into question the industry’s social license to operate: How can the financial system works for everyone and not just shareholders? In 2015, 196 countries signed the Paris Agreement to reduce carbon emissions.
Most recently, the COVID-19 pandemic demonstrated the connectivity between crises: Public health, climate change and social inequality. In response, companies prioritized even more ambitious goals around ESG.
Three main ESG Investing strategies are growing quickly. Negative Screening typically excludes investments related to weapons, tobacco and fossil fuels. While exclusions were historically based on moral or religious preferences, now it’s about the financial risk associated with the negative impact of industries, such as human health for tobacco and climate change for fossil fuels.
ESG Integration has become the leading strategy. It focuses on how companies incorporate ESG criteria into their daily activities to achieve long-term financial performance. Then, ESG considerations and timelines are factored into risk analysis and investment decisions moving forward.
Impact Investing is the newest strategy. It intentionally aims to create positive social and environmental impact that is actively measured, as well as financial return. Like investing in the private debt of a company with a business model aimed at providing access to high-quality education for students from low-income backgrounds. Impact Investing is becoming increasingly common because more people want their money to contribute to the United Nation’s Sustainable Development Goals.
The ESG lens can be applied to any asset class. While equity is the most common, representing half of total ESG assets under management, green bonds are on the rise. Typically purchased by institutional investors, they help finance a company’s specific project climate-related or environmental project.
Sustainability-linked bonds are also gaining traction. These are performance-based and tied to whether the issuer achieves pre-defined ESG objectives within a set timeline.
Many investors are now looking beyond ESG targets and are increasingly focused on measurable results with clear plans. This trend, along with wanting more of a say in a company’s ESG practices, is expected to continue for the next several years.
Heightened regulation including environmental, employment, and civil protections, is another factor driving ESG market growth. Around 90 percent of oversight was implemented in the last 20 years and 50 percent arrived after 2010.
Europe leads this effort, where public companies are required to report implemented policies and where regulations are constantly evolving to reflect broader sustainability goals. Take the EU Green Deal, a set of policies to help the EU reduce emissions 55 percent by 2030 and reach net zero by 2050.
But sustainability challenges are global and require mobilized capital to solve them, all countries are working on ESG. Asia is beginning to implement its own regulations, and the U.S. administration is currently working on its own standards as well.
For the next several years, innovation will continue to shape the ESG landscape. From advancements in clean energy, like the growing hydrogen market, to how companies will deliver on advancing racial equality, and the upcoming public investments on clean infrastructures, all eyes are on ESG.