Environmental impact strategy
We are witnessing a rapid shift in values toward sustainability on a global basis; investors, consumers, companies and regulators are all starting to consider new ways of doing things and starting to adapt their lifestyles and business practices to be more considerate of environmental issues. While this reorientation of society still has a long way to go, it is making the idea of “sustainable investing” a significant theme in the investment industry.
Sparked perhaps by Greta Thunberg and other well-known public figures, we see the Millennial generation and Gen Z as driving forces behind this shift, and they are spurring others into action. These two generational cohorts, which claim more vegetarians and vegans than any other in the modern age, are vocally committed to environmental and social issues, and their voice is empowered by the mobile phone and the broad global reach of the social media channels.
Businesses, investors, governments and regulators are all playing catch-up in this changing landscape. Investors are learning fast to appreciate the importance of sustainability in society and the business world, and therefore the need to adopt an ESG (environmental, social and governance) framework in their investment decisions.
From avoiding losses to solving problems
There are a number of different approaches to integrate ESG and sustainability into an investment decision process. The aim of ESG integration, the most important and commonly used ESG approach, is to integrate material ESG factors across the investment process – from research and security valuation through to portfolio construction and monitoring – in order to make better-informed investment decisions. Best-in-class strategies typically limit the investable universe of companies to those with above-average ESG ratings in their industry. Other strategies simply avoid potentially problematic areas such as sectors with extremely high energy intensity, or which use rare earth metals or other limited natural resources. Other strategies emphasize their active engagement with company managements to encourage better business practices to improve ESG issues.
Clients who would like their investments to have exposure to firms that offer solutions in the environmental or social area can choose strategies that focus on investment themes aligned with the UN Sustainable Development Goals (SDG). Investing, for example, in companies that develop clean energy technologies or recycling or climate change mitigation solutions. The purity of a fund’s exposure to its theme is clearly a critical issue, which clients need to monitor closely. Some funds that claim to offer a theme focused on environmental solutions may in fact have very little direct exposure to the advertised climate change solutions. Caveat emptor. The greater the purity to the theme, the greater the exposure to firms with a positive contribution to the SDG.
ESG integration in China
Some more tactical ESG strategies focus on evaluating a company’s ability to raise their game and improve their ESG credentials from a low starting point. This is particularly pertinent in emerging markets, and in the case of China, where ESG considerations are still generally lower down the list of management priorities. However, this is rapidly changing. According to a study by the United Nations (UNEP FI/PRI)1, in 2009 only 43% of the largest 300 companies on the Shanghai stock exchange (the CSI 300 Index) voluntarily disclosed ESG data. By 2018 this proportion had risen to 82%. In addition to reporting more ESG statistics, the country is also moving with the times, and adopting more sustainable energy solutions. China’s solar energy installation footprint is slated to rise by 50% before the end of 2025 – an incredible achievement with a meaningful impact on rolling back the effects of climate change.
Sustainable investing not only helps the environment and society but is also starting to prove to be a positive factor in investment performance. Perhaps this is a self-realizing “virtuous circle.” As the popular momentum behind sustainability increases and more investors adopt ESG integration processes, companies that score well on this front are likely to perform better than those that score poorly. This surely is free market capitalism at its best: allocating capital responsibly, to improve sustainability and deliver investment performance, and by the same token punishing companies that show little regard for raising their ESG ratings, or to the economic externalities they create.