Environmental, Social and Governance (ESG)

Nobody interested in investing could have missed the meteoric rise of Environmental, Social and Governance (ESG) as a buzz phrase in recent years. Indeed, since the beginning of the coronavirus pandemic, it has become absolutely ubiquitous. But what does it mean, and why should investors care?

First let’s unpack what the components of this hear-it-everywhere acronym mean. The “E”, for Environmental, is self-explanatory, referring of course to the green or environmentally friendly aspects of an investment. The “S”, for Social, is little more nebulous, standing for how much an investment contributes to things we would all regard as being positive for society, such as education and equality. Lastly, the “G”, for Governance, refers to how well corporate entities run themselves in a broad sense. This is very wide ranging and might mean limiting excessive executive pay so that workers are paid fairly across the board, ensuring that workforces right up to board level are diverse, or that the company treats the data privacy of its customers with due regard.

You will be probably be thinking by now that ESG is an incredibly wide term, that can mean different things to different people – and you would be correct. The use (and some might say abuse) of the term ESG has become such a phenomenon that critics have argued that it has become almost meaningless. An often-touted statistic is that ESG assets have come to equal the value of almost half the market cap of the world’s major stock markets. With that the case, how much could such credentials mean?

It would be easy to feel slightly cynical about ESG investing and to see the term as something of a marketing ploy. But that is to miss an incredibly important point: ESG investments have shown themselves to perform better than non-ESG investments for the simple reason that well-run companies which are conscious of the wider costs of pollution or not treating their role in society seriously tend to be more profitable. They are not as exposed to risks like bad publicity or fines, and they tend to think more about the longer term. They, and their profits, are sustainable in the broadest sense.

Of course, investors do have to be cognisant of the fact that ESG is vulnerable to spin. Yet by taking a robust approach to ESG which is evidence based, this approach to investing can really help reduce portfolio risk and boost returns, while also helping improve the world.

You will be hard pressed to find a wealth manager today which doesn’t profess to offer ESG services in some manner. There is, however, a wide gulf between the leaders and the laggards in this field. Some will only be picking investments on the basis of an ESG label, whereas others have deep knowledge in this area backed up by top-level data and research. The best will use five or more ESG data providers to get the deep and broad coverage they need, for instance.