By Richard Hartung
From garment factories protecting workers better, to banks ending loans for coal miners, companies are focusing more on sustainable environmental, social and governance (ESG) practices. Investors are looking at it more, too, as corporate practices affect investment returns. Here’s how to include sustainability in your investment decisions.
Companies Are Becoming More Sustainable
While calls for responsible corporate management date back at least to the Quakers in the US in the 1800s, companies only began to develop more comprehensive ESG practices about 15 years ago. The focus has intensified in recent years, as more people prefer to buy from companies with environmental and social practices that match their own values.
The range of issues that ESG covers is quite broad. Beyond climate risk, for example, environmental concerns include natural resource scarcity, pollution and waste. Social issues include labor practices, product liability and how a company cares for the community. Also, governance includes corporate reporting and board member quality.
The reason companies are now more interested in ESG goes beyond just ensuring a better environment and society. Good environmental practices help control costs, position a company for growth and make it more valuable. Good social practices, such as treating workers well, benefits society and helps a company retain talent, and good governance leads to better corporate decisions and strategy.
Unilever, for example, found in its research that over half of consumers already buy or want to buy sustainable products. It then developed ‘sustainable living’ brands which have a clear purpose relating to social or environmental practices. Walmart and IKEA have similarly moved toward sustainable retailing by reducing waste and using renewable energy.
Sustainability Benefits Investors
Along with benefitting the planet and the company, better ESG practices are good for investors, too.
A study by Bank of America Merrill Lynch, for instance, found that firms with better ESG records than their peers produced higher three-year returns, were more likely to become high-quality stocks, were less likely to have large price declines and were less likely to go bankrupt. The US-based Chartered Financial Analyst Institute similarly said that stocks with high ESG scores have higher valuations and lower volatility than their less-conscientious counterparts. When BNP Paribas compared the MSCI World Index and the MSCI ESG Index, a senior advisor for responsible Investments Kanol Pal said, “There is outperformance in ESG.”
Even amid the coronavirus-caused market crash, results show that better ESG practices can be beneficial. The MSCI ESG Leaders index outperformed the EU benchmark by 1.8% from January through mid-March, according to the Financial Times. “The evidence so far suggests that ESG has been more resilient,” Morgan Stanley equity analyst Jessica Alsford told the Financial Times, and ESG funds withstood the market sell-off better than most others.
Looking ahead, Saxo Bank Head of Equity Strategy, Peter Garnry, says some green stocks “could, over time, become some of the world’s most valuable companies - even eclipsing the current technology monopolies. Investors should consider tilting their portfolios towards green stocks so they don’t miss this long-term opportunity.”
How to Select Investments
The question for investors, then, is how to select stocks of companies with better ESG performance.
One way is to analyze individual companies’ ESG practices. Once you select a stock you want to invest in, you can review the MSCI ESG Ratings or ratings in the US, or the ESG report that companies file with the Singapore Exchange (SGX). You can use the reports to determine whether its EGS practices match your own values.
A less time-intensive method is to use an exclusion policy, so that you avoid companies in sectors such as coal production, weapons or palm oil production.
Investors can also put their money in ESG unit trusts or exchange-traded funds (ETFs). While there are few ESG ETFs in Singapore, there are more than 80 in the US. Investors could select one using sources such as the ETF.com website and invest through a brokerage firm with access to US markets.
While it is still important to select companies or funds based on sound financial fundamentals, adding ESG as another factor and analyzing company practices carefully can give investors better returns while helping the planet and our society, too.