This three letter acronym is becoming more and more prevalent across the portfolios of fund managers and retail investors alike as companies move towards more sustainable business models.
The value assigned to ESG data has sky rocketed over the last decade, and this is directly related to the fact that 50 years ago, approximately 85% of company value was based on tangible assets. These days it is quite the opposite; about 85% of a company’s value is comes from intangibles like Intellectual Property.
So what is ESG?
As we stated in one of our previous articles “How do Social-Fintech raise capital?” the term ESG (Economic, Social, Governance) emerged in 2006 after the UN Global Compact, in collaboration with the International Finance Corporation and the Swiss Federal Department of Foreign Affairs published “Who Cares Wins”. The same year the UNEP/Fi published the “Freshfield Report” in which they demonstrated that ESG measurements are relevant for financial valuation. These two reports acted as the main pieces of evidence for the release of the Principles for Responsible Investment (PRI) at the New York Stock Exchange in 2006 and the launch of the Sustainable Stock Exchange Initiative (SSEI) in 2007.
Below are the 6 UN Principles for Responsible Investment (PRI):
- We will incorporate environmental, social and corporate governance (ESG) issues into investment analysis and decision-making processes.Signatories can follow the first principle by supporting the development of ESG-related tools, metrics and analyses and by encouraging research and analysis by service providers and academics on ESG-related issues.
- We will be active owners and incorporate ESG issues into our ownership policies and practices. Signatories can follow the second principle by promoting and protecting shareholder rights and by engaging with companies on ESG issues.
- We will seek appropriate disclosure on ESG issues by the entities in which we invest. Organizations can ask companies to integrate ESG components into their annual financial reports and request standardized reporting of ESG issues through tools such as the Global Reporting Initiative (GRI). The GRI is a sustainability reporting effort that asks organizations to disclose their impact on issues such as climate change, human rights, and corruption.
- We will promote acceptance and implementation of the principles within the investment industry. Signatories can communicate their ESG expectations to service providers and revisit relationships with providers that do not adhere to ESG guidelines.
- We will work together to enhance our effectiveness in implementing the principles. Organizations can collaborate to address new issues and support initiatives by sharing information, tools and resources.
- We will each report on our activities and progress towards implementing the principles.Through this principle, organizations can raise awareness of ESG principles among stakeholders and beneficiaries.
How is it calculated?
There are thousands of metrics used to calculate a businesses’ ESG rating, ranging from carbon offsets to customer feedback, below we have a number of categories supplied by Refinitiv who offer ESG quantifying services (find their report here).
However, what constitutes an “acceptable” ESG score can be entirely qualitative, and is determined by the investor or investing party.
Growth in Responsible Investing
The reason for the increase in ESG is not only the increasing concern for global warming, gender equality and corporate social responsibility, but also the fact that investors can “do good by doing good”; the realization that investment opportunities, (whether it be a PLC or LTD) that operate within a sustainable model are more likely to produce better returns, for longer. Data below from Global ESG Quarterly Volumes — Refinitiv shows that investment allocations that include a small allocation to ESG equities offer better returns for the level of risk taken in most cases.
The astounding acceleration of ESG investing should be an excellent indicator of its bright future. ESG has the potential to transform the investing landscape and be a worldwide force for good.