The three pillars. Why ESG investments are rapidly taking over the world
Many Russian companies also claim to adhere to the ESG principles. In 2018, the rating agency RAEX named the leaders of responsible domestic business that effectively cope with environmental, social and managerial problems. They were Lukoil, MMK, Gazprom, Tatneft and Alrosa.
A responsible approach
The abbreviation ESG is made up of the first letters of the words environmental, social, and governance. These are three factors that are taken into account when investing in a company — environmental, social and managerial.
- climate change due to the company's activities
- greenhouse gas emissions
- waste production
- depletion of natural resources, including drinking water
- reduction of forest area.
- working conditions, including the use of children as workers
- gender composition of the company health
- protection in the enterprise
- relationships with consumers and local communities
- relations with suppliers.
- long-term strategy of the company
- audit and internal control
- composition of the Board of Directors
- remuneration of management
- rights of shareholders.
Taking into account these factors allows a fund engaged in ESG investments to make an informed decision about investing in securities of a particular company. In general, this means that the corporations selected with the help of this filter conduct socially oriented business, are distinguished by high-quality management and concern for the environment.
At the end of 2018, another study from EY appeared on the relationship between non-financial information (and this is just ESG) and investment decision - making. It has reached more than 200 investors worldwide.
"In the last few years, there has been increasing evidence of the impact of trade on climate change. We have also witnessed scandals related to poor corporate governance. In addition, there is a new understanding of the impact of business on society. Institutional investors are increasingly using non-financial indicators as an important component of investment decision — making," the study authors write.
According to EY, 97% of investors conduct either an informal assessment of ESG indicators, or a structured and methodical analysis of non-financial data on corporations. Over the year, the indicator increased by almost 20 percentage points: previously, the share of such investors was 78%. It is noteworthy that at the end of 2018, only 3% of respondents reported that they were not interested in ESG factors at all. In 2017, they were 22%, in 2015-48%.
Specialized funds evaluate and study companies that implement the ESG principles. For example, since February 14, 2019, the Swedish fund of Russian shares, Alfred Berg Ryssland, which is under the advice of TKB Investment Partners (JSC), began to use an ESG filter in its strategy.
This is the first Russian securities fund in the world that adheres to a socially responsible approach to investing. In other words, when a specific decision is made to invest money in shares, Alfred Berg Ryssland evaluates companies from the Russian Federation in terms of ESG criteria.
It is important for the fund's clients to know that the selection of shares takes into account the company's environmental, social and management indicators, emphasizes Anita Lindberg, responsible for ESG at Alfred Berg. The fund's specialists collect all the necessary information directly from companies, use the assessments of third-party organizations, and consult with the TKB Investment Partners team. As a result, all issuers that do not pass through the ESG filter are simply eliminated.
But the ESG principle is used not only at the stage of selecting securities of an organization. Recently, these criteria have become a guide to action when making strategic decisions. There are cases when disgruntled shareholders put pressure on the management, forcing the company to behave responsibly. In the fall of 2017, Australia's largest bank, the Commonwealth Bank of Australia (CBA), became the first financial institution in the world to file a lawsuit for insufficient disclosure of information on the impact of climate change on the company's operations.
The fact is that the CBA funded the Carmichael coal project. The use of coal in the energy sector is a sore point for Australia. The country is moving away from this resource in the direction of clean energy, and the society, including the holders of securities, ensures that the investment policy is consistent with the environmental one. As a result, CBA announced a complete withdrawal from investment in coal projects.
The Australian energy giant AGL also did the same — coal-fired power plants will cease to function by 2022, instead the company will use solar, wind and water energy. "We do not consider the development of coal — fired generation to be economically rational," AGL explained its decision. After that, the Australian media wrote that investment in coal is no longer possible. According to Influence Map, the country's coal industry has lost hundreds of billions of dollars in investment in recent years.
Gradually, ESG moves from the ethical to the economic plane. Take the example of clothing manufacturers. Fashion houses Gucci, Michael Kors, Jimmy Choo and Armani have abandoned the use of natural fur and switched to synthetic materials. Shoe manufacturer Nike reduces the use of genuine leather, it is replaced by a material from the already recycled leather Fly Leather.
Such a policy is aimed not only at protecting the environment and animal rights, but also provides an opportunity to significantly reduce costs. The production of a single faux fur coat takes 15 times less energy than a fur coat made from captive-bred animals. Moreover, artificial materials are usually much easier to process and give designers more opportunities to choose colors and textures. In turn, the production of Fly Leather shoes allows you to reduce water consumption by 90%. In addition, non-natural components do not require careful transportation and special storage conditions.
Percentage of responsibility
Of course, using an ESG filter does not allow you to hope for a fabulous profit. This approach to investing is aimed at long-term sustainable performance and can be considered conservative. In particular, the global ESG index of developed countries over the past 10 years has shown a yield of 11.5% against 45.2% at MSCI World.
Yet responsible investments are in demand. In 2017, the British company Schroders surveyed 22 thousand investors around the world. Almost 80% of them reported that investing in companies that adhere to the principles of sustainable development has become much more important for them than five years ago.
In January 2019, the American company BlackRock published the results of a survey of its customers. This is about 230 structures under the management of which there are more than seven trillion US dollars-public and private pension funds, insurance companies, charitable organizations. More than half of the respondents (51%) said that they are going to review their investment strategy. Almost a third (27%) of investors surveyed spoke about the growing importance of the ESG principle in decision-making. BlackRock customers from EMEA countries — Europe, the Middle East and Africa-were the most likely to talk about this.
Taking into account the growing interest in the ESG segment, the use of these principles is beginning to have a positive impact on the effectiveness of investments. Thus, the French investment company Amundi (1.3 trillion euros under management) carefully studied the profitability of portfolios compiled taking into account ESG factors. The analysis included the shares of 1.7 thousand global companies for the period from January 2010 to December 2017. It turned out that since 2014, there has been a positive relationship between responsible investment and the return on securities.
Thus, in the European market, the yield from the purchase of 20% of shares of companies with a high ESG rating and the sale of 20% of securities with a low rating gave 6.6% per annum in the period from 2014 to 2017. A similar strategy applied in 2010-2013 would have shown a loss of 1.2%. The US market has slightly different indicators: +3.3% and -2.7%, respectively.
A responsible approach to investing has been known to mankind for several centuries. The prototype of the ESG approach was ethical investment. Often their use is associated with various religious movements. For example, as early as the 17th century, the Protestant Quaker community forbade its members to conduct financial transactions related to slavery. In the Islamic world, it is forbidden to invest in companies or projects related to the production of alcohol or gambling. Another example is the work of the Church of England Foundation (assets — about 16 billion US dollars). This structure does not invest in the production of weapons, cigarettes, alcohol and pornography for ethical reasons. Norway's trillion-dollar Sovereign Wealth Fund does not invest in companies dealing with nuclear weapons, tobacco products, or coal.
According to Vladimir Kirillov, General Director of TKB Investment Partners (JSC), ESG is becoming a more significant factor for international investors. And funds whose investment process is built around ESG are actively gaining popularity. Kirillov notes that today in the world more than 20 trillion US dollars are managed using the ESG principle — this is a quarter of all assets in trust management.
Thus, investing with an eye on ESG is not just a fashion trend or a momentary desire to please public opinion. A company that conducts business responsibly is most often managed with an eye to strategic progressive development. This means that it can serve as a reliable object for investment.