Today, when major investors evaluate into which companies they will choose to place funds, they evaluate much more than just the company’s financial profile.
They look at factors like diversity on the board and in the workplace. Blackrock, the world’s largest asset manager, recently stated that it would not invest in companies that did not employ a sufficient ratio of women. They also look hard at how the company relates to the society around it.
One of the most important categories in this non-financial evaluation of investment targets is ESG, which stands for Environmental, Social and Governance.
Investments in about $30 trillion in assets have relied in some way on ESG ratings, according to estimates from the MIT Sloan School of Management.
For the ‘E’ in ESG, investors look hard at how a company’s activities affect the environment. An increasing number of institutional investors have dropped companies that mine fossil fuels from their portfolios. They are shifting funds from fossil fuel extractors to renewable energy producers, or to clean coal, for example.
For the ‘S’ in ESG, investors consider the role of a company in society. Does it have a purpose that transcends making money, one that also does good to the community around it?
For the ‘G,’ the prime consideration is how well a company is run, looking at leadership, executive pay, audits, internal controls, and shareholder rights. There is particular interest in the treatment of employees as stakeholders, assuring their well-being and their working conditions.
One should not dismiss ESG investing as something for ‘tree huggers and do-gooders.’ ESG investing pays off too. According to data from fund researcher Morningstar, 62 per cent of global environmental, social and governance-focused large-cap equity funds outperformed the global tracker.
ESG investing also provides added information and insight about likely long-term performance. There is clear evidence of improved long-term returns for companies with high ESG ratings.
In a recent research paper, DWS argues that the crisis has incited investors to insist even more strongly on ESG investment.
Many companies have taken steps during the crisis to help employees and to contribute to their communities in crisis.
Clearly, even when the crisis is over, investors will take ESG commitment by companies as an important factor in their investment choices.
ESG investing is slated to become part of the ‘new normal.’ Retail investors should also begin to take it into account.