Ethics and Investing are probably two words you won’t often find together. From scandals to pollution. Greedy executives to blatant rights violations. Corporations have carried out many environmental and social harms over the years in the name of profits.
Traditional financial models have long focused almost exclusively on monetary factors. That’s to say that, If a project was expected to make money, it was a go! Even if it caused a greater cost to others. Because of this, regulations have been introduced overtime to ensure that corporations who tend tofocus exclusively on profitability, operate in a way that is aligned with the interests of other stakeholders. From minimum wages to pollution restrictions, these regulations have come to be fairly broad in their scope.
However, while these rules can prevent blatantly harmfulactions, they’re many grey areas that regulations do not address.
As generations become more aware, educated, and active on social and environmental issues, several investors have started to take it upon themselves to support only companies that align with their own values. This has in effect fostered frameworks such as ESG or otherwise known as Environmental, Social and Governance.
The ESG elements
Taking all this together, what you’ll be looking at is not only how to assess a company by looking at it’s balance sheet, but also how it impacts the broader society at large.
ESG investing therefore is an approach that considers not only the financial gains of a corporation, but also the direct and indirect effects that the company has on the well-being of others. This framework is used in analysing companies, andassesses how well they compare to their peers in terms of performance against these metrics.
Why should investors care?
ESG can be extremely rewarding for investors. Most investors often think about money as the only way to measure success, but ESG helps broaden the spectrum by considering a broader range of measures.
Here are some of the benefits of ESG investing:
Investing in ESG-oriented companies can potentially help the environment and mitigate climate change. Green bonds, for example, are focused on environmental objectives, including reducing carbon emissions to improve air quality.
By focusing on responsible investing, investors can reduce the risk of losing money tied up in their investments. ESG investing – through negative and positive screening, helps investors avoid companies that have questionable practices or are irresponsible. These companies are often relatively susceptible to higher rates of failure.
Most ESG-focused companies have sustainability strategies and tend to have better operational efficiency, cost savings, lower employee turnover, innovation, retained talent, reduced compliance costs, and risk management. All of which may help to outperform their competitors over time and increase shareholder value.
For many investors, fees are a major factor when deciding how to invest their money. Companies that have sustainable business practices tend to be more efficient and cost-effective over time. This is because they might not necessarily need massive advertising campaigns to boost sales or spend large sums on luxury items for their top executives – and this might translate into a reduction in the company’s overall cost.
In a Nutshell
On one hand, companies need investing to fuel their wealth and accomplish their financial objectives. On the other, investing can enable these organisations to carry out wrongdoings. This leaves investors in a tough predicament. And while ESG investing could serve as an aid in solving this problem, the framework comes with its fair share of drawbacks. The most prominent drawback being that the framework significantly renders itself to being subject to people’s opinions – and rightly so, as different people will have different views of what they consider to be importantwithin the framework.
For some people, Environmental could be important. For others, Social or Governance could be more important. Therefore, unless a bespoke portfolio is built for every individual investor, then there has to be a compromise on how the ESG framework is to be applied. However, investing with at least one of the ESG facets in mind, is proving to be better than the traditional methods of investing.
The author is a Chartered Accountant, working with one of the big four auditing firms.