ESG has been thrust to the centre of American politics.
An ‘anti-ESG’ bill that would have prevented US corporate pension managers from considering environmental, social and governance (ESG) factors when researching investments passed through the US Congress. But it then became the first legislation vetoed by President Joe Biden since he took office in January 2021.
The amount of money invested in funds that consider ESG factors has ballooned in recent years, thereby boosting the economic and political significance of ESG. In some ways, it’s no surprise that ESG has made it into the crosshairs of some politicians.
What’s causing ESG scepticism?
ESG has been tarred with the ‘woke’ brush by some Republican politicians. Some also incorrectly think it means limiting your investment universe to companies doing good, like electric vehicle makers and renewable energy producers. This has naturally agitated US legislators in states that are highly dependent on the oil and gas industry.
But ESG scepticism partly stems from a misunderstanding of what it aims to achieve. When integrating ESG, no area is off-limits, as long as you consider the ESG risks and opportunities and factor them into the investment case for each company.
It’s not just for 'greener’ investors either. Lots of mainstream fund managers have recognised the benefits of ESG and are integrating it into their investment process, although some have made more progress than others.
A lack of standardised definitions and investment process transparency has muddied the water. This ambiguity has caused some companies and fund managers to overstate the progress they’ve made integrating it into their processes – a practice known as greenwashing. This has damaged trust in the industry, and increased investor scepticism.
Why we think it’s important to consider ESG
Governance has always been a central concern for most investors. Things like whether a company has a high-quality leadership team, and whether its managers are incentivised in a way that aligns with shareholders’ interests, are important considerations for any investment.
Environmental and social issues have become more prominent recently. Some investors might wonder if it’s necessary to consider these issues, especially if they’ve invested successfully for a long time without doing so.
However, the world has changed profoundly over the last few years. Like many countries around the world, the UK has committed to achieving net zero carbon emissions by 2050. This will mean large scale changes across the economy. Entire industries will need to adapt or face obsolescence.
Investors who fail to recognise these risks could find themselves holding on to companies that are economically unviable in a low-carbon world, or that own a high number of ‘stranded assets’. That’s where a previously valuable asset becomes inefficient to continue using before it reaches the end of its useful life.
The risks extend beyond climate though. If a company fails to manage its exposure to environmental and social risks, it’s more likely to encounter controversies which damage its reputation.
This matters today more than ever. In a world dominated by social media, a company's misdeeds appear on the news feeds of millions in a matter of hours, potentially sparking outrage, backlash and boycott.
Millennials (those born between 1981 and 1996) are more interested in sustainability than any generation before them. They're the largest living adult generation and willing to change their buying habits based on their views of a company’s sustainability credentials.
As their wealth continues to increase over time, they have the potential to reward sustainable companies. But also severely punish those that fall short of what they expect.
Sorting the wheat from the chaff
If you invest in funds, it can seem difficult to sort the fund managers taking a sincere approach to ESG from those that aren’t. If you want to find out how a fund manager approaches ESG, you can start by checking the fund documents, like the factsheet. A fund manager’s website can also help.
You could also check that the fund house is signed up to industry initiatives, like the UN-backed Principles for Responsible Investment (PRI). When companies sign up, they make a commitment to incorporate ESG issues into their investment processes, and to develop their approach over time. It’s easy to do, just visit the PRI website and search the name of the fund house to see if it's signed up.
Finally, look for third-party endorsement. Fund managers who’ve made the most progress implementing ESG might receive recognition for their efforts. They might even be asked to comment on their approach or views in the financial press.
This article isn't personal advice. If you're not sure if an investment is right for you, ask for financial advice. All investments fall as well as rise in value, so you could get back less than you invest.
Considering ESG issues can form a part of your investment analysis and decision-making process, but it shouldn’t be a replacement for fundamental financial research.
ESG in action – First State Stewart Asia (FSSA)
FSSA (through its parent company First Sentier Investors) has been a signatory to the PRI since 2007 and has consistently received high scores in its annual assessment report. That means the PRI has independently agreed that the company's responsible investment practices meet its highest standards.
The parent company is also a globally certified B-Corporation. This is another independent certification that the company meets the highest standards of social and environmental performance, transparency and accountability.
The group produces an annual Responsible Investment Report which goes into lots of detail about its ESG processes. It also gives a full breakdown of the company’s voting activity, as well as engagement case studies.
We’ve backed several FSSA funds on the Wealth Shortlist (and its predecessor lists) for a number of years. For the team at FSSA, ESG considerations are much more than a label or box to be ticked. Taking these factors into account is a natural extension of the same investment process they’ve used for decades.
The team’s philosophy is founded on stewardship – when they make an investment, they see themselves as part-owners of the business and want to make sure it’s run in a way that’ll benefit all shareholders.
ESG issues form a core part of this. For example, they don’t like companies that make reckless decisions in the pursuit of short-term gains, rather than focusing on longer term, more sustainable growth. A business shouldn’t exploit its workforce, take advantage of tax loopholes, or skirt around industry legislation. Importantly, it should cause little, if any, harm to the environment around it.
Learn more about responsible investing
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