Small changes, big impact: Why you should stay invested in ESG
In September last year, the Continental Group conducted an audience survey(1) as part of its popular webinar series. About 78% of respondents chose ESG as a leading investment trend. At the time, this resounding consensus was largely correlated with people’s newfound awareness of sustainability. The ESG-positive sentiment has been ubiquitous, as evident from an HSBC survey(2) where over 80% of investors expressed their belief in ESG.
However, the same survey revealed that only a quarter of their investments considered ESG factors. So, why did the belief not translate to behaviour? For starters, the gap can be attributed to a lack of information and perception of low returns compared to conventional investment strategies. And since ESG proponents are largely youngsters, who tend to have fewer savings and a low-risk threshold, a large-scale impact has been elusive thus far. If you’re a potential investor, you are likely to seek the rationale to stay invested in the ESG promise.
ESG is imminent
Multiple studies have established the global consensus on the need for greater compliance with ESG factors. These developments were fueled by increased digitalization and pandemic-induced re-prioritization. Such tailwinds are likely to supercharge your ESG-led investments. And, if the continued post-pandemic emphasis on sustainability is any indication, these sentiments are here to stay. However, while markets are largely sentiment-driven, investors are moved by numbers. Operating under this assumption, a few studies have quantified the ESG impact. Lately we have seen modern investors craze has increased towards ESG and they have realized it's not always about high gains but balance your investment portfolio with a social cause.
A comparative, cross-sectional study(3) has revealed 3.8% higher returns in firms with strong ESG ratings. Likewise, ESG investing has been correlated to better investment allocation and improved risk management, especially in dynamic market conditions. ESG-compliant firms’ higher returns stem from lower costs of borrowing in the securities market — as lenders find encouragement in greater transparency, reporting standards, and less likelihood of public backlash. Such firms are primed for greater stability and associated growth. They also allow investors to obtain certain tax benefits, subject to local policies.
ESG: The bona fide vs the fad
Perhaps the biggest roadblock plaguing investors is the inability to determine ESG credibility. This arises due to the highly fragmented ESG landscape and distinctive scoring mechanisms. And the lack of a central ESG authority and scoring standards gives way to unethical ESG practices by profit mongers. In fact, several “greenwashing” instances have been reported in recent months. So, this begs the question: How to determine credible ESG investing opportunities?
According to Morgan Stanley(4), investors must factor in metrics such as absolute carbon emissions, carbon intensity, emissions reduction targets, carbon earnings at risk (CEaR), and climate change revenues of firms. Firms which emphasize such metrics in their periodic ESG reports and measure progress merit greater attention. As do firms whose reportage follows global ESG standards such as Global Reporting Initiative (GRI), Principles for Responsible Investment (PRI), etc. Some have detailed decarbonization strategies or net-zero emission targets in place, besides the periodic carbon audits, to cater to potential investors. Discerning global investors also tend to favour jurisdictions with coherent green taxation.
However, one must understand that, as investments flow into ESG-compliant stocks, they increase in value — which, in turn, reduces relative returns. This could discourage investors who are looking for short-term gains. But, with ESG now predicated on structural trends, compliant stocks are bound to rally, giving potentially higher returns in the due course. So, it is advisable to harbour a long-term outlook on ESG investing. When it comes to investing as a responsible citizen one should evaluate companies not only based on financial parameters but also on non-financial parameters
At any stage, if the process of determining ESG credibility and making strategic investments becomes complex, get in touch with our proficient financial advisors for timely guidance.