ESG Investing Explained: How To Invest in a Better, More Sustainable Future
Joel Kohâ—Ź
Over the coming decade, we expect to see a “greening” of traditional sectors of our economy…Green finance is one of the fastest growing segments.
~Lawrence Wong, Singapore’s Finance Minister at Budget 2022Â
You are probably thinking, “What is Green Finance?” You are not alone.
If you don’t know what ‘Green Finance’ means, does this mean you don’t care about the environment?
Jokes aside…If you are still learning about investing, are not a climate enthusiast or follow the Singapore Green Plan closely, you may not know what ‘Environment Social and Governance (ESG) Investing’ means.
Many countries, including Singapore, have committed to achieving a Net Zero Emissions economy. This is in response to climate science indicating that lowering carbon emissions alone will not suffice to avert climate change. ‘Net zero’ means that emissions are compensated for by absorbing an equal amount of carbon dioxide from the atmosphere.
This paints the backdrop for the urgency to combat climate change and perhaps invest in a manner that aligns with these efforts.
TL;DR: What is ESG Investing, ESG’s Factors and Their Relevance to Investors, Investors’ Inertia & Notable ESG Assets
Click here to Teleport:
- What is ESG Investing
- ESG factors and their relevance to investors
- Investors’ inertia
- Notable ESG assets
1. What is ESG Investing?
Sustainability Investing/Financing, more commonly known as ESG Investing, refers to:
The practice of integrating environmental, social and governance (ESG) criteria into financial services to bring about sustainable development outcomes, including mitigating and adapting to the adverse effects of climate change. Singapore’s financial sector can play a useful role in catalysing sustainable and green finance in the region.
~Monetary Authority of Singapore
FYI: ESG Investing is sometimes termed sustainable, socially responsible, and mission-related investing under the ESG Investing umbrella.
ESG Investing is a strategy for investing in financial assets evaluated to create a positive impact (relative to their competitors) on the environment, social issues, and corporate governance.
This means the possibility of investing in companies in the renewable energy industry or companies with equal employment opportunities and a diverse management team.
These companies will be scored on environmental and social responsibility scales as determined by third-party agencies.
2. Is ESG Relevant to Investors?
So, why is ESG Investing relevant?
Based on a report from Morningstar, a global investment research and financial services firm, the global sustainable fund assets expanded by 9% in Q4 of 2021.
A survey conducted by HSBC also found that the COVID-19 pandemic has expedited increased awareness of ESG issues worldwide, and 80% of investors in Singapore believe in ESG.
The same survey reported that almost half of the investors in Singapore believe their portfolio will comprise 100% sustainable investments within the next three to five years.
Ultimately, the world’s largest asset manager, BlackRock, is pushing companies to disclose how they will survive in a world of net-zero greenhouse gas emissions.
It publicly announced that ESG factors would be guiding all their decision making moving forward, prompting the investment community to follow suit.
In theory, this strategy aims to do good AND gain returns.
I suggest that you grab a cuppa to slowly digest the information below.
How Are ESG Factors Evaluated?
ESG Investing is the strategy and practice to integrate ESG factors into investment decisions. These are some credible disclosure/reporting frameworks that score companies’ ESG efforts:
| Frameworks/Reporting Standards | |
|---|---|
| Global Reporting Initiative (GRI) | Created in 1997, the GRI is used to help businesses, governments, and other organisations understand and communicate their impacts on ESG issues such as climate change, human rights and corruption. Source: Global Reporting Initiative |
| Principles for Responsible Investment (PRI) | The PRI is a voluntary framework for ESG investment decision-making and ownership practices issues. The PRI is supported by the United Nations and developed by Fidelity International. Source: United Nations Principles for Responsible Investment |
| Morgan Stanley Capital International (MSCI) | The MSCI measures long-term resilience and ESG risks through a scoring system, from 'CCC - laggard' to 'AAA - leader'; ratings parse over 1,000 data points for risk exposure on 80 industry-specific and geographic metrics. This is useful if you are an institutional investor looking to build a portfolio or establish benchmarks. Source: Morgan Stanley Capital International |
| Sustainable Accounting Standards Board (SASB) | The SASB is a non-profit organisation founded in 2011 to develop sustainability accounting standards. In 2018, it published a set of ESG standards specific to 77 industries, each with a set of financially material topics and associated metrics. Source: Sustainability Accounting Standards Board |
| Task Force on Climate-related Financial Disclosures (TCFD) | The TCFD has developed a framework to help public companies and other organisations disclose climate-related risks and opportunities. Source: Task Force on Climate-Related Financial Disclosures |
| United Nations Sustainability Development Goals (SDG) | The SDGs address global challenges in the form of 17 goals to create a better future for people and the planet. Some goals include eradicating poverty and hunger, strengthening environmental protection, achieving peace etc. Source: United Nations Sustainability Development Goals |
See below for examples of common ESG factors measured:
| Environment | Social | Governance |
|---|---|---|
| Looks at the changing environmental conditions that have increased the depletion of natural resources and the risks imposed by environmental challenges, including physical risks (assets, infrastrutures), transition risks (associated with shift in policies and needs) and human risks (associated with labour force and social consequences). | Looks at the company's culture, human resource practices including treatment towards its employees, stakeholders, customers etc. It also extends to the impact the company's practices have on the broader society | Looks at the management's quality, diversity of the management, their business ethics and how effective they are in managing ESG issues. |
| Natural resource scarcity | Labour policies E.g. Does the company adopt healthy and fair wage growth model | Transparency and disclosure E.g., How forthcoming is the company with information? Is the information disclosed comprehensiveness, accurate and consistent? |
| Carbon footprint/Greenhouse Gas Emissions | Occupational Health and Safety E.g., Does the company have high workplace safety standards? | Executive compensation E.g., Executive compensation structure |
| Renewable energy | Child Labour/Human rights record E.g., Does the company have a bad or good track record in ensuring that such practices are not adopted? | Anti-Corruption E.g., Does the company has Anti-Corruption Behaviour policies in place? |
| Pollution and waste | Diversity and Equal Opportunity E.g., Does the company adopt policies ensuring workers are not discriminated against based on gender, race, religion etc.? | Relationships with internal and external stakeholders, including employees, customers, supply chain partners, investors, communities and civil society |
| Materials | Product safety E.g., Does the company has a good product safety record? | Independence of the management E.g., Conditions that enable the members of the highest governance body to exercise independent judgment free from any external influence or conflicts of interest. |
| Biodiversity | Anti-discriminatory/Fair practices E.g., An organisation can take an active role in reviewing its operations and decisions, in order to promote diversity, eliminate gender bias, and support equal opportunity. | Communication of critical risks and concerns E.g., How effective has the management been in engaging stakeholders to reduce or identify potential unforeseen risks |
Note: This list is non-exhaustive. You should research the respective standards/frameworks for deeper analysis.Â
If ESG Investing is all about doing good and gaining returns, why aren’t investors rushing to adopt it?
3. Investors’ Inertia
The inertia to kickstart an ESG investing journey is real.
Like you, as someone who just started learning about investing, I’m still figuring out the nuts and bolts. We’re not millionaires (for now), and we’re using our hard-earned money to invest.
Investing takes risks, and you should always assess your risk appetite, investment horizon and financial goals to understand if ESG Investing is suitable for you.Â
There are challenges imposed when researching ESG-focused investments.
There is currently a lack of a standardised approach to measuring companies’ ESG performances, and this has led to different appraisals by raters.
One of our Seedly contributors also mentioned that apart from ESG efforts, various components such as market cap size, location, and industries/sectors might have created biases towards a company’s ESG scores.
Without a harmonised methodology, there might be inconsistencies in the ratings of one single company. For instance, companies that obtain a good score from one rater might be given a contradictory score by another rater.
As a result of the many variables, investors are also left to fend for themselves in making an informed decision.
The Problem of ‘Green Washing’
The absence of consistent standards enables ‘Green Washing’.
‘Green Washing’ refers to creating a false impression or providing misleading information about how a company’s products are more environmentally sound.
In 2015, Volkswagen ran commercials and advertisements that portrayed the company as spending a large amount on its clean diesel cars, making them safer for the environment. However, an exposĂ© unravelled Volkswagen’s image, leading to its then-CEO Martin Winterkorn’s resignation.
Most recently, Deutsche Bank AG’s asset-management arm, DWS Group, was under investigation by the US Securities and Exchange Commission and federal prosecutors for allegedly overstating its ESG credentials, which eventually led to a series of probes.
Given that ESG-themed products tend to attract investors wishing to make an impact, greenwashing could lead to resources and attention being allocated away from the world’s pressing sustainability needs.
ESG & Financial Performance
There have been reports that ESG investments outperformed the traditional funds, including:
- Morgan Stanley Institute for Sustainable Investing reported that sustainable funds outperformed traditional peer funds and reduced investment risk during the pandemic in 2020.
- The Economist Intelligence Unit (EIU) found that nearly 74% of 450 institutional investors it studied have indicated that their company’s investments that integrated ESG factors performed better financially than equivalent traditional investments in the three years before 2020.
While we note that past performances do not indicate future performances, some past studies have also outlined an encouraging relationship between ESG and financial performance.Â
A meta-study by the University of Hamburg (cited by S&P Global on its website) found a positive ESG-Financial Performance relation in 62.6% of meta-studies and 47.9% of vote-count studies.
Another meta-study by the NYU Stern Center for Sustainable Business and Rockefeller Asset Management also found a positive relationship between ESG and financial performance.
It found that 58% of the studies focused on operational metrics such as Return On Equity, Return On Assets, or stock price, with 13% showing neutral impact, 21% mixed results (the same study finding positive, neutral or negative results) and only 8% showing a negative relationship.
The takeaway from the second study was that the improved financial performance due to ESG becomes more marked over a longer time horizon.
This suggests that we might have to look at a longer investment horizon should we want to see positive/better returns on investment from ESG investing.
ESG’s growth has been driven by the desire of investors to have an environmental and social impact, along with the economic performance of investing.Â
We can’t deny the growing interest in sustainable investing, which saw many economies putting in efforts to improve their social and environmental issues.
4. Notable ESG assets
If you intend to embark on ESG investing, here are some notable ESG investments you can research further:
ESG Exchange Traded Funds (ETFs)
- iShares ESG MSCI USA Leaders ETF (SUSL)
- iShares MSCI KLD 400 Social ETF (DSI)
- iShares MSCI USA ESG Select ETF (SUSA)
- SPDR S&P 500 ESG ETF (EFIV)
- Nuveen ESG Large-Cap Value ETF (NULV)
- Vanguard ESG U.S. Stock ETF (ESGV)
- Vanguard S&P 500 Growth ETF (VOOG)
Robo Advisors With ESG Portfolios
- Endowus
- Syfe
ESG Funds
- UOB Asset Management’s United Sustainable Credit Income Fund
- Allianz Global Sustainability Fund
- Vanguard FTSE Social Index Fund
- Parnassus Endeavor Fund
- BGF Sustainable Energy Fund
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised financial advice. Readers should always do their own due diligence and consider their financial goals before committing to any financial product and consult their financial advisor before making any decisions.
Closing Thoughts
The above pointers should have enlightened you that incorporating ESG factors into company policies is increasingly crucial. One of the reasons for this is the COVID-19 pandemic, which is believed to be a positive catalyst for ESG Investing.
As the Singapore Government pushes forward to achieve Net-Zero emission by 2050 and a sustainable future, the Monetary Authority of Singapore (MAS) also announced that it intends to set up new disclosure standards for Singapore retail ESG funds. This is a developing area and continues to be so.
I always believe that if you have done enough research and are aware of what you’re committing to, go ahead and do it.
