Sustainable investments or ESG (Environmental, Social and Governance) is an investment concept which has been on the rise for the past couple of years and is one of the most current topics.
ESG concepts or criteria are a set of standards for the activities of a company that socially-aware investors use to filter potential sustainable investments. Environmental criteria consider how a company performs as a guardian of nature. The social criteria examines the way it manages relations with employees, suppliers, customers, and the communities in which it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
If we look a bit deeper, environmental issues will include the company’s use of renewable energy sources, its waste-management programmes, its investments in new clean technology (for example green buildings) and the company’s attitude and actions regarding climate change.
For instance, a company may face environmental risks due to ownership of contaminated land, an oil spill, its management of toxic emissions at the disposal of hazardous wastes, or compliance with the government’s environmental regulations.
The environmental aspect of ESG is maybe the one that is most close to the public since it is something more tangible and very much on top of the global agenda.
When it comes to the social aspect, this can take various forms including human rights, gender equality and safety at the place of work, child labour and other human-related issues. Lastly, the governance concept is also important as it looks how a company is managed by its top executives. This includes board independence, board diversity, mitigation of conflict of interest, anti-bribery and corruption policies, board transparency, and others.
The ESG investment concept has boomed over the past couple of years and in fact, since 2014, investment flows have increased by around €30 trillion. There are various reasons as to why we have seen increasing interest, but this mainly depends on the ideas, beliefs and values of the individual investors. Over time, many, especially those of a younger age, are becoming more conscious of climate change and the challenges we are facing due to severe weather.
The ESG investment concept has boomed over the past couple of years and since 2014, investment flows have increased by around €30 trillion- Christian Buhagiar
In addition to this, the political landscape, motivated by the European Union, is also driving this agenda, following agreement that the planet needs to become carbon-neutral by 2050. We are also seeing more employees demanding more gender equality and health protection. Many investors are also expecting more integrity and accountability from public officials and private executives, especially after various corruption and money laundering scandals across the globe.
One common approach to invest in the ESG theme is by utilising a ‘negative screener’. This strategy will avoid exposure to companies that work in controversial sectors such as fossil fuels, tobacco, arms manufacturing, animal testing, alcohol, intensive fish farming, and others. Contrary to this, one can adopt a ‘positive screener’ to strategy, whereby investment will be done only in companies that contribute positively to the society.
This can include renewable energy companies, companies that practise equal pay for equal work, companies that are pioneers in diversity, and others. Lastly, an investor can also utilise the concept of ‘engagement’. In this way, shareholders will be active in the company by opening dialogues with the management and encourage them to improve their practices on the ESG concept.
There are various investment instruments which can be utilised to access this concept. As mentioned, one can invest directly in shares that are impacted directly or indirectly by this theme. This can be, for instance, a company manufacturing wind turbines or electric cars. One can also invest in ‘green bonds’ which are bonds that utilise capital collected for environmental or social projects.
It is imperative, however, to note that investing directly in the market involves a lot of risk and extensive research is needed. An investor must not make the mistake of investing in a company only just because it is part of the ESG theme without looking at the fundamental values of the company.
On this front, a practical way one can invest is to utilise actively-managed funds. In this way, the investor would have exposures into different sectors, including such important themes like ESG, without being overexposed to a particular theme or company.
Christian Buhagiar is portfolio manager at BOV Asset Management Ltd.