Author: Hitesh Pindoria, Liqueo Senior Consultant
Although ESG investment is not a new concept, it has become a hot topic over the last year. But are ESG factors correctly understood by the wider industry?
When you’re investing are you matching your money to your morals? Or are you likely to brush aside your morals when it comes to producing profits?
As we become more informed about the impact of ESG, how likely is this to change our mindset when investing?
When it comes to ethical investment, times aren’t just changing, they have already changed significantly. We see this around us in everything from the increase of Vegan choices to the implementation of ULEZ in London.
What is ESG?
ESG stands for Environmental, Social and Governance. This refers to the three core factors that measure sustainability of an investment.
Environment
Environmental criteria cover all aspects of the environmental impact of an organisation – based on its actions. These may include a company’s carbon emissions, the waste and pollution it creates, how it conserves natural resources, and the way it treats animals.
The criteria are often used in evaluating any environmental risks a company may face and how the company is managing those risks.
Holding organisations to better environmental requirements might both assist the fight against climate change and also reduce the chance of fines or being caught short of increasing environmental legislations.
The benefit to investors is to recognise their cash can be used for a greener future.
Social
Social criteria cover the organisation’s business relationships. This would look at aspects including anything from employee diversity, company sexual harassment policies, human rights, and customer satisfaction to fair labour practices, as well as taking stakeholders’ interests into account.
Following the recent pandemic, treatment of employees’ post-furlough arrangements, reducing hours and deciding on redundancies has put many organisations in the spotlight.
Social factors are not just about how consumers judge a company’s behaviour. Geopolitical events also have a part to play, as such conflicts can have a direct impact on the pricing, production, and distribution of their products. A recent example of this was the September attack on an oil refinery in Saudi Arabia. Yemen’s Houthi fighters claimed responsibility for the attack, although Riyadh pointed the finger at arch-rival Iran. Either way, it pushed il prices to above $70 a barrel for the first time since January 2020.
Governance
Governance criteria cover the organisation’s structure and how it is run – along with aspects of transparency and reporting, company ethics, compliance, and shareholders’ rights.
How much focus would you place on the bosses paying themselves hefty sums when profits are low or employees lower down the scale are failing to see any wage increases?
This is based on a justifiable belief that the mood within the organisation filters down. Happy employees equate to a better-performing workforce.
To take a more cynical view, it could be said that it has little to do with ethics but rather building a strong leadership model, overseen by a trustworthy team and dependable management, to deliver consistent growth to an organisation’s shareholders.
Benefits of ESG investing
Putting ethics aside, it would be worth considering other persuasive benefits to ESG Investing.
Risk vs Return
A 2019 Morgan Stanley white paper found that sustainable funds continued to show lower downside risk than traditional funds, regardless of the asset class. The study demonstrated that during the turbulent markets of 2008-2009, 2015, and 2018, traditional funds had a higher potential for loss due to a larger downside deviation than sustainable funds1.
Investment research company Morningstar analysed 26 sustainable fund performances over 2020, of which 25 outperformed its alternative traditional peers2.
Challenges of ESG Investing
There are over 140 different ESG data providers that provide data research in a variety of forms.
The most commons ones known are:
– Sustainalytics ESG Risk Ratings
– MSCI ESG Ratings
– Bloomberg ESG Disclosures Scores
– FTSE Russell’s ESG Ratings
– S&P Global ESG Scores
– Moody’s ESG Solutions Group
From reading the ESG criteria, you may have gathered that factors considered are not always directly tied to financial returns or creditworthiness. Instead, it measures the wider impacts on society and the environment, which are, understandably, very subjective. There is no common definition of impact or measure of ESG rating across data providers. This, therefore, leads to open interpretation.
ESG ratings are primarily based on public data scaping. However, ESG rating providers also distribute lengthy ESG questionnaires on issues for additional information. This instantly gives large organisations an upper hand, as they have more time and resources to fulfil the additional information requirements vs small to mid-size firms. As such, the latter are potentially marked negatively on rating as a result of missing data. The FCA highlighted that “there is also often limited opportunity to correct misunderstandings or misinterpretation of [the issuer’s] responses by the rating provider,” all of which can lead to “market distortion.”
Given the lack of data, does this mean that the rating is more influenced by perception?
CEO Elon Musk of Tesla Inc. has not been shy about giving this opinion on this matter, saying the ways of measuring ESG are “fundamentally flawed”. He was very vocal when Tesla received a worse ESG score than two oil companies.
Sustainalytics scored Tesla 28.5 (the lower score the better) with a “medium risk” score based on Exposure and Management.
Sustainalytics notes:
“Exposure refers to the extent to which a company is exposed to different material ESG issues. Our exposure score takes into consideration subindustry and company-specific factors such as its business model.” 3
“Management refers to how well a company is managing its relevant ESG issues. Our management score assesses the robustness of a company’s ESG programs, practices, and policies.” 3
The two oil companies that scored better than Tesla are OMV AG and Repsol with scores of 26.9 and 26.7 respectively.
GRC World Forum published an article in February 2022, where the author pointed a finger directly at Elon Musk for being the main reason for a lower rating. This was based on the reflection of Tesla’s transparency, labour relations and adherence to governance – i.e. control of a CEO’s ability to send out random Tweets – along with the statement made on its 2019 impact assessment report5, where it stated:
“Making a significant and lasting impact on environmental sustainability is difficult to achieve without securing financial sustainability for the long term.”
In summary, it appears to be heavily geared toward perception and interpretation.
Being ESG compliant
For better or worse, the concept of ESG is definitely on investors’ minds. This push has seen a sudden influx of asset managers wanting to obtain ESG data from various vendors so they can demonstrate their ability to invest responsibly and manage risk against the wider market.
Here at Liqueo, we provide organisations with the skills to implement programmes successfully through our flexible workforce model, tailoring solutions for our clients’ strategic goals. We deliver an exceptional, bespoke service to every client via a dynamic and agile framework. If you are interested in how we can help you implement successful programmes or want more ESG data reporting, contact us.
References
3 https://www.sustainalytics.com/esg-rating/vicinity-centres/the-bidvest-group-ltd/1008555180
5 https://www.tesla.com/ns_videos/2019-tesla-impact-report.pdf
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