Recent years have seen no shortage of corporate scandals, showing how poorly governed businesses can have a devastating effect on employees, shareholders and the communities in which they are based.
Increasingly, fund managers publicly say they are pushing companies to become better global citizens, making sustainable returns for investors, while also putting in place solid governance structures.
Gary Waite, portfolio manager at Walker Crips Investment Management, says that while investing utilising ESG integration techniques is well established in the institutional space, it has only recently begun to gain traction among retail investors.
“Evolution in policy and regulation such as the Task Force on Climate-related Financial Disclosures (TCFD) in 2015, the Paris Agreement (COP21) in 2016 and the UK’s Climate Change Act in 2019 have been significant drivers of the asset management industry adopting enhanced disclosure and stewardship procedures,” he explains.
“Failing to factor in ESG considerations during the fundamental analysis of a stock or bond serves to potentially misprice that asset in a portfolio, viewing it through a risk lens.”
However, Kunal Sawhney, CEO at Kalkine, says that corporate governance can only help organisations avoid biased decisions but will not guarantee an ethical performance.
“The basic criteria for selecting organisations for an impact investing strategy is that they need to be doing positive work in a quantifiable manner,” he highlights.
More than a feel good factor
“There have been various studies that have shown that this investment strategy not only gives the feel-good factor for the investments one is owning but can also reduce portfolio risk and generate competitive investment returns, rather than putting money in companies that some or other way are hurting people and the planet.”
According to an Accenture study, an estimated US$30 trillion of assets may pass from baby boomers to millennials over the next three decades.
As the younger generation is more in tune with ethical investing, the demand for ESG, sustainable and impact investing is predicted to grow substantially.
Waite says there is still a lingering suspicion of a ‘performance discount’ on anything with a green tinge in spite of a substantial body of evidence supporting the view that you cannot have structural outperformance over the longer term without due consideration of E, S and G factors.
He adds: “Many clients are put off by terminology and don’t want the perceived risk of doing something ‘virtuous’ at the expense of their net worth.
“ESG portfolios can display significantly more volatility versus their standard benchmarks due to typically being materially underweight and/or excluding large constituents of the index from oil and gas companies to firms engaged in the alcohol, gambling and tobacco industries.”
Waite adds that investors may not always realise that portfolios with ethical credentials could effectively be a proxy for new technologies, dynamic management teams and efficient processes, all of which are accretive to alpha over time.
There is no denying that recent years have seen a marked shift in investor sentiment towards ESG, but more education is needed around what ESG integration actually represents, experts say.
“One of the most significant objections by advisers and their clients is the lack of standardisation with all firms having their own interpretation,” Waite says.
“Any move to make ESG investing more uniform via regulation or widespread adoption of an industry-recognised standard to enable meaningful comparisons between investment solutions would be well received. It also serves to avoid those firms who simply greenwash marginal strategies to grow assets under management.”