ESG Investments. The New Investment Mainstream?

Global climate change, the binding international goal for a transition to a low carbon economy under 2 degrees, the recent new EU Sustainable Investment Disclosure Rules, the new EU Directive for Non-Financial Reporting, the UN Sustainable Development Goals, the market driven self-regulation initiatives such as TCFD, the market proof as well as studies that show, that on ESG KPIs reduce risks and identify opportunities, the demand from institutional and retail investors for more ESG relevant products, the demand from clients and society for more transparency in investments and more sustainable brands, the weak corporate governance and recent scandals due to it, water scarcity, community conflicts, resource depletion, supply chain breakdowns, worker well-being, economic & gender inequality etc. can all present material risks and opportunities to businesses.

ESG Investments become an imperative for successful corporations, asset owners and asset managers. ESG market growth trends figures & trends, outperformance of ESG indices & funds VS Mainstream Indices & funds as well as relevant ESG studies, confirm, that companies and investors with strong sustainability cultures & good ESG KPIs, outperform their laggard peers. The business case for integrating ESG factors into mainstream investment practices has never been stronger.

-ESG Investments, the new investment mainstream? Why to integrate ESG factors into the investment strategy and why most mainstream market players internationally not only offer already a variety of ESG products/funds but also promote them in an active way.

ESG Market in terms of total ESG assets under management, new ESG products/funds, number of new ESG players, which turn from mainstream to ESG, which offer also ESG products, number of PRI Members, all are growing rapidly and there is an ongoing positive trend, especially in Europe after the new relevant EU Sustainable Investment Disclosure Rules.
ESG funds perform in general well and in some cases outperform in comparison to mainstream funds, especially during turbulent times and on midterm – long term timeframe.
The policy at EU level (EU Sustainable Investment Disclosure Rules since March 2019) but also national initiatives (Initiatives in France, Netherlands, Luxemburg, Germany, UK etc.) encourage ESG investing.
The materiality of ESG factors on financial performance and risk evaluation is becoming a mainstream.
Institutional Investors ask for Investment strategies with ESG factors.
NGOs & Society put pressure for more ESG Investments & for brands with sustainable approach.
ESG Metrics give the possibility to investors to identify gaps in corporate governance, regulatory, reputation, environmental, social, operational, market, sectoral risks, which the financial KPIs do not show.
ESG give you the chance to evaluate & analyze the non-financial KPIs & how sophisticated is the company’s strategy.

The new EU regulation on Sustainable Investment Disclosure Rules sets out how financial market participants and financial advisors must integrate environmental, social or governance (ESG) risks and opportunities in their processes, as part of their duty to act in the best interest of clients. It also sets uniform rules on how those financial market participants should inform investors about their compliance with the integration of ESG risks and opportunities. Following are the main pillars of the Regulation as they are stated and expressed by the European Commission.

Elimination of Greenwashing (unsubstantiated or misleading claims about sustainability characteristics and benefits of an investment product) and an increase of market awareness on sustainability matters;
Regulatory Neutrality: the rules introduce a disclosure toolbox to be applied in the same manner by different financial market operators. The three European Supervisory Authorities (ESAs), and in particular the Joint Committee of the Authorities, will ensure further convergence and harmonisation of disclosures in all the sectors concerned.
Level playing Field: the regulation covers the following financial services sectors: (i) investment funds; (ii) insurance based investment products (life insurance products with investment components available as individual retail life policies as well as group life policies); (iii) private and occupational pensions, (iv) individual portfolio management; and (v) both insurance and investment advice.

-Following are the main commonly recognized ESG Strategies to follow:

Negative – Exclusionary Screening: The exclusion from a fund or portfolio of certain sectors, companies or practices based on specific ESG criteria (e.g. alcohol, gambling, tobacco, weapons, fossil fuels etc.).
Positive – Best in Class Screening: Investment in sectors, companies or projects selected for positive ESG performance relative to industry peers (electromobility, renewables, innovative technologies etc.).
Norms based screening: Screening of investments against minimum standards of business practice based on international norms (e.g. the company to publish GRI Report, incorporate UN SDGs etc.).
Integration of ESG factors: The systematic and explicit inclusion and integration into investment strategy by investment managers of environmental, social and governance factors into financial analysis (Perhaps the most sophisticated strategy).
Sustainability themed Investing: Investment in themes or assets specifically related to sustainability (for example wind energy, electric cars company or sustainable agriculture).
Corporate Engagement and Shareholder Action: The use of shareholder power to influence corporate behavior, including through direct corporate engagement (i.e., communicating with senior management and/or boards of companies), filing or co-filing shareholder proposals, and proxy voting that is guided by comprehensive ESG guidelines.
Impact Investing (a separate unique category): Targeted investments, typically made in private markets, aimed at solving social or environmental problems, and including community investing, where capital is specifically directed to traditionally underserved individuals or communities, as well as financing that is provided to businesses with a clear social or environmental purpose (The investment should have a substantial social impact).

-The Dialogue Process at the different phases of Investing Process, must take a more structured process both at ESG & Mainstream Investing. Why the development of a structured dialogue process (stakeholder engagement process with concrete phases) by every investor -ESG & Mainstream- (institutional, retail, asset manager etc.) with the equities, which holds in its portfolio can prevent him from unforeseen investment risks as well as help him identify new investment opportunities. Perhaps this is one of the best reasons, why ESG is the new Mainstream. The main elements of such a necessary structured stakeholder process:

Research as Investor the companies in your portfolio on relevant new ESG topics per company.
Set short-term, mid-term and long-term ESG Goals per company according to company’s profile and ESG principles.
Inform and update companies on ESG/Sustainability Developments, and hold a series of meetings with companies per year to keep update and help them to improve ESG scores & performance.
Identify the right contact person for ESG/Sustainability/Investor Relations issues in company and build relations.
Define roles in the team for this work either per company or per portfolio.
Initiate the contact to the company for ESG material issues and raise the issue and the cause/purpose with different ways, formats (e.g. Email, official letter, meeting, raising the seniority of contacting per timeline phase etc.) in a diplomatic way.
Request for a meeting with Senior Management & then with Executive Management & BoD.
Escalate the issue in different ways and at different levels of seniority, in different format and with different ways (e.g. position the topic also on media if necessary in order to put pressure).
Reminders techniques-formats.
Follow up techniques-formats on topic, in case the company will not adopt the request.

-Four main trends in ESG in the coming years:

More new ESG Market Players: It is estimated that ESG Market, both in terms of assets under management as well as number of ESG market players, will grow further in the next years and ESG will become the new mainstream.
From exclusion to greater ESG Integration. Investors are moving to adopt ESG across the entire portfolio, from ESG-focused funds to products such as green bonds and impact investing.
Greater Engagement. Asset managers plan on working more closely with shareholders, such as in filing/co-filing resolutions, and with corporate leaders, to accelerate action.
More Sophisticated & ESG relevant Reporting. The driver for greater transparency and accountability, means investors expect greater demand not just to report on their actions, but also on impact and outcomes.
More divestments in specific sectors. Especially on nuclear weapons, tobacco, coal etc.

-The Challenges in ESG. We need common international ESG Standards. The ESG market practice, the positive trend, many studies and various surveys confirm a gap between intention and action by many investors and asset managers in ESG. While the vast majority of professional asset management firms apply at least one form of the recognized ESG strategies, the number of the ones, which apply more ESG strategies consistently or a combination of them and with transparency across portfolios is still small, but it is growing.

The recent relevant EU Regulation is contributing in that direction, but there is a need for adoption of ESG common international standards like we have the international accounting standards. It must be also discussed and clarified which of the existing and applied ESG relevant investment strategies, all of them or only some of them are accepted and recognized all as equally ESG relevant, since not all are the same complex, not all follow the same ESG criteria and processes and not all lead to same results. For e.g. The ESG integration is much more complex and sophisticated investment strategy in comparison to the exclusion, which is a relative simple strategy, that ESG beginners follow.

All above if not confirm, at least are good indicators, that ESG Investments is turning from a niche trend to the new mainstream.

Global Sustain GmbH part of Global Sustain Group (https://globalsustaingroup.com/) is organizing for 4th consecutive year in cooperation with Forum for Responsible Investment (FNG) & SEB AB Frankfurt the 4^th ESG Responsible Investments & Sustainable Finance Forum 2019 (http://esgconference.com/) in Frankfurt on 21.5.2018 at the Conference Center of SEB AB Frankfurt. For more information & forum registration please visit http://esgconference.com/.