Too Important to Ignore.
Applying ESG — environmental, social and corporate governance criteria — to investing decisions is no longer a niche, it's mainstream. Many of the world's largest asset owners are now leading the sustainable investing movement, developing increasingly sophisticated approaches to integrating sustainability into their investment strategies and mandates.
In fact, many major asset owners now pursue a strategy of direct investor engagement to ensure that sustainability is a priority for the management and boards of directors of the companies they invest in.
According to the Global Sustainable Investment Review, total assets committed worldwide to sustainable and responsible investing grew significantly between 2016 and 2018. In Europe they rose 11%, to reach $14.1 trillion. The United States recorded growth of 38%, hitting $12 trillion by the start of 2018, while in Japan, sustainable investing assets grew from just 3% of total professionally managed assets to 18%.
Even those impressive numbers do not tell the full story. A recent survey conducted by Responsible Investor in collaboration with UBS found that in the pension fund space, “Corporate boards seem to be waking up to the necessity of taking ESG into account when making the long-term investment decisions necessary for their pension funds, and also to joining up their position on finance to corporate sustainability branding statements and commitments.”
What accounts for the expanding interest? Respondents in the survey identified three major factors:
• The risks associated with not taking ESG into account.
• The positive effect on financial performance.
• Fiduciary duty.
The conviction that there are risks involved in not taking ESG into account is informed in large part by the growing threat of climate change. There are many measures of that threat.
According to the International Association of Insurance Supervisors, for example, insurance losses from severe storms were 60% higher in 2018 than in the preceding 16 years. Given the likelihood that extreme weather events will become more frequent as climate change progresses, the association has defined climate and sustainability issues as a strategic priority for the insurance industry.
A report from the consulting and advisory firm Mercer puts it even more starkly: If the planet is allowed to continue heating up, good investment opportunities will shrink significantly. The report notes that in the event that temperatures rise more than 2 degrees Celsius (3.6 Fahrenheit) over three timeframes — 2030, 2050 and 2100 — almost every sector will suffer, with industrials and agriculture hit hardest.
It is the risk factors associated with climate change coupled with the growing recognition that ESG integration has a positive impact on financial performance that has elevated sustainable investing in the minds of many investors to the level of fiduciary duty. This trend is confirmed by survey respondents who, when asked to identify the issues they believe will be material to their investments in the next five years, placed systemic environmental factors such as the climate crisis and biodiversity loss at the top of their lists, suggesting that over time, these could become even more important than financial factors.
This is why many investors are keen to engage directly with companies to learn how they approach issues like climate risk and to gain a better understanding of the likely financial impact of those risks.
Several studies demonstrate the financial benefits of company engagement, including research led by Professor Elroy Dimson of the London Business School that found it can improve profitability for investors as measured by returns on assets. By contrast, companies where engagement objectives had not been met saw no change in return on assets.
One high-profile example of company engagement is global energy producer Equinor. In collaboration with Climate Action 100+, which represents $33 trillion in assets under management, Equinor has announced it will “put climate at the core of its business strategy,” set measurable climate-related emission targets beyond 2030 and strengthen the link between its climate-related targets and remuneration for senior executives and employees. Equinor joins several global energy giants, including BP and Shell, in responding directly to investor concerns about climate risks.
For growing numbers of investors, company engagement programs form an integral part of their investment analysis, which ultimately informs whether or not they include that company in their portfolio.
For directors and their boards, ESG is a consideration they can no longer afford to ignore. The recent momentum toward sustainable finance thinking combined with the direction in which the natural world is headed means that ESG must permanently secure its place in the boardroom as well as in the financial and investment world.
Michael Baldinger is a managing director and global head of sustainable and impact investing for UBS Asset Management.