In the wake of the COVID-19 pandemic, interest in "sustainability" has increased significantly, and the investment world is no exception. ESG investment involves considering not only financial factors but also non-financial factors, such as Environmental (E), Social (S), and Governance (G) aspects, to generate better returns and manage risks in investment decisions. ESG encompasses a wide range of issues, from avoiding investments in tobacco companies to supporting clean water initiatives, and it goes by various names such as sustainable investing, responsible investing, ethical investing, and impact investing.
The ESG elements are categorized as follows:
- Environmental: Climate change, greenhouse gas emissions, resource depletion (including water), waste and pollution, deforestation.
- Social: Labor conditions (child and forced labor), indigenous/local communities, conflict areas, health and safety, labor relations and diversity.
- Governance: Executive compensation, bribery and corruption, political lobbying and donations, board diversity and structure, tax strategy.
The concept of ESG has evolved over time. Initially, it mainly referred to socially responsible investing based on religious beliefs. Later, ESG investing involved avoiding or excluding assets and industries with negative social impacts. However, it has now evolved into a more modern approach of shareholder activism where investors directly engage to drive positive change.
ESG investment's growing popularity can be attributed to increased accessibility to information. With 24/7 news channels, the internet, and social media, the public has easy access to vast amounts of information. This heightened information accessibility has brought greater attention to the investment industry. Companies have become more sensitive to public opinion to avoid damaging their brand reputation, affecting both the allocation of institutional investors' funds and the asset allocation and engagement strategies of asset managers.
ESG investment is significant for two main reasons. First, it relates to the social role that investors play, and second, it is about risk management. Institutional investors like pension funds, charitable organizations, and endowments see their role extending beyond pure profit-seeking. They focus on broader social responsibilities, including managing retirement funds, funding social initiatives, and contributing to education costs.
ESG investors hold considerable influence due to their large assets under management, granting them significant power. As such, they seek investments that positively impact society and avoid those with negative societal consequences. Some investors incorporate ESG factors in their investment processes to manage risks. For example, investing in companies with low ESG standards may expose investment portfolios to risks like labor strikes, lawsuits, and negative public opinion, potentially leading to lower future returns.
Contrary to a common misconception, adhering to ESG principles has been traditionally associated with negative impacts on corporate financial performance. However, according to Fidelity International's research, adopting ESG criteria for investment decisions has been shown to improve financial performance. Studies have indicated a positive correlation between ESG factors and corporate financial performance, with over 50% of cases showing a positive correlation and only 11% showing a negative correlation.
ESG investing methods are gaining popularity among general investors globally. Approaches include direct investment in ESG stocks or bonds, indirect investment through funds or ETFs, or investment in ESG-themed products. When considering ESG funds, investors should review asset management reports to verify which assets are categorized as ESG and included in their funds. It is also important to avoid products that falsely claim ESG investment without adhering to its principles.