What is Sustainable or ESG Investments?
PRI (Principles for Responsible Investment) defines responsible investment as “an approach to managing assets that sees investors include environmental, social and governance (ESG) factors” to better “reflect investor and beneficiary values” and “combine better risk management with improved portfolio returns”. Responsible investments, or ESG investments, allow you to take into account environmental, social and managerial factors in the investment decision-making process. When making investment decisions, economic agents focus not only on the steady growth of company’s financial performance but also on non-financial information related to the principles of these firms activities in the areas of environmental protection and social responsibility.
What ESG factors do investors care about?
In modern conditions (interest in climate change, the COVID-19 pandemic, the fight against corruption, the fight for gender equality, and so on), the practice of applying socially responsible investment criteria will continue to spread. Accordingly, in order to attract investors, firms should strive to meet the ESG criteria.
Examples of ESG factors:
Environmental issues
- Climate change
- Greenhouse gas emissions
- Depletion of natural resources (including lack of drinking water)
- Waste and pollution
- Deforestation
Social networks
- Working conditions (including slavery, child labor)
- Local communities
- Health and safety
- Gender equality
Management issues
- Remuneration of top management
- Bribery and corruption
- Political lobbies and donations
- Structure and gender composition of the Board of Directors
- Tax strategy
In 2018, Amundi Asset Management found that the relative importance of ESG factors depends on the region. For example, in the United States, a large role is paid to the problem of environmental protection, and in European countries-to the quality of management. In 2019, PwC surveyed 165 leading investors from 35 countries and concluded that the most important factors influencing their investment decisions were business ethics (89 %), corruption and theft (87%), and security and fire safety (83%). The least significant factor was working with volunteers (13 %).
Responsible Investment Strategies
Benefits for companies and investors
There are several benefits that apply to investors or directly to companies and manufacturers of certain goods:
- Mitigate Risk – unsustainable or irresponsible corporate practices increasingly expose companies to risks. Responsible investment helps minimize potential corporate image issues.
- Enhance Returns – in a recent study by Nucleus Research, findings show that consumers are willing to spend 6% more for products from companies that have sustainability commitments and programs in place. Alongside these findings, the research showed that consumers were 64% more likely to recommend companies with sustainable practices to friends and were 63% more likely to try new products from these companies.
- Ensuring the internal priorities of the company with priorities in the field of environmental protection, community development and corporate governance.
- Cost reduction.
- Improving the efficiency of activities.
- Development of new products / technologies.
- Creation of new business models.
Quantifying sustainable investments
ESG-based investment assessment has been gaining momentum in recent years. In particular, in 2017, the British company Schroders surveyed among 22 thousand investors from all over the world. The results of the study showed that for 80% of respondents, investing money in companies that adhere to the principles of socially responsible behavior has become much more important than five years ago.
At the end of 2018, Ernst & Young conducted a study that looked at the relationship between non-financial factors (ESG factors) and investment decision-making and covered more than 200 investors from all over the world. The data obtained showed that when evaluating investment projects, most investors rely on non-financial indicators (in 2018, about 97 % of investors evaluated investment projects using ESG criteria, while in 2017 this value was 78 %). The study also revealed that in 2018, only 3 % of investors were not interested in ESG criteria at all when evaluating investment projects, while in 2017 this indicator was 22 %, and in 2015 — 48 %, which indicates the widespread use and application of ESG criteria.
According to PwC, the volume of responsible investment capital increases by a third every two years. At the same time, about half of all managed assets in Europe are classified as responsible investment assets, and 83% of investors pay attention to the climate risks of portfolio companies.
Volume of responsible investment capital and its share by region
| Region/Year | 2016 | 2018 | ||
| Volume | Share of all managed assets | Volume | Share of all managed assets | |
| Europe | 12.04 | 52.16% | 14.075 | 48.80% |
| USA | 9.723 | 21.60% | 11.995 | 25.70% |
| Japan | 474 | 3.40% | 2.18 | 18.30% |
| Canada | 1,086 | 37.80% | 1,699 | 50.60% |
| Australia and New Zealand | 516 | 50.60% | 734 | 63.20% |
| Total | 22.89 | 30,683 |
It should be noted that the ratings of different rating agencies and consulting companies may differ. It can be caused by the fact that these organizations take into account a different set of data when analyzing non-financial information of companies.
According to the global sustainable investment survey (GSIA) 2018, sustainable investment assets exceeded $ 30 trillion worldwide at the beginning of 2018, an increase of 34 % since 2016. As of November 2019, more than 2,600 organizations have already signed up to the UN Principles for responsible investment (PRI), with more than 500 new organizations joining the Principles in 2018-2019 alone, according to the PRI annual report 2019[1].
The structure of investors is dominated by institutional ones, but their share in the responsible investment market is gradually decreasing. So, in 2012 they accumulated 89 % of the market, while at the beginning of 2018 their share decreased to 75 %.
Conclusion
Thus, today, ESG investments account for about a quarter of all professionally managed funds worldwide. There is a growing public understanding that ESG ratings are an indicator of both the company’s long-term performance, including profitability, risk, the moral and ethical values that the company follows. the effectiveness of applying ESG criteria in investment practice will depend on a number of factors:
- understanding the importance of socially responsible investments in the business community.
- transparent and consistent state policy in the field of sustainable development of territories, including standardization and control over the disclosure of financial and non-financial information of the company.
- creation of a competitive environment and orientation of economic agents to develop investment strategies based on the concept of “long” money.