A noticeable shift in values has taken place globally as concerns increase regarding the continued exploitation of vulnerable communities and the rampant destruction of the environment. While there has been vocal support for a shift towards finding sustainable solutions among global communities, companies and governments have not always been as quick to enact change. However, a failure to adapt to the consumer demand for ethical investment could leave some companies behind as they are overtaken by their more sustainable and ethical competitors.
Environmental, social and corporate governance (ESG) investing has become an opportunity for businesses to tap into the growing social demand for lasting change as well as the emerging ESG-related market. The resulting growth in environmental and ethical consciousness is leading both consumers and investors to demand that companies take these values into account. Sustainable financing and future-proofing are fundamental in the context of global islands, and ties into the core part of our mission at Island Innovation.
“Depressed returns and volatility in oil markets will likely weigh on investor sentiment for the foreseeable future, thereby boosting the attractiveness of renewable energy projects offering lower-risk, longer-term visibility on the earnings of oil majors.”
What is ESG investing?
Ethical investing is when an individual decides to invest their money in a company that aligns with their views. For example, an individual could choose to not invest in companies that carry out animal testing or are tied to fossil fuel companies. This is what is called negative screening, where an investor avoids certain companies – and it is expected to become more prevalent.
ESG stands for Environmental, social and governance and “are a set of standards for a company’s operations that socially conscious investors use to screen potential investments”.
(James Chen,Investopedia, 2021)
Until quite recently, ethical investing was a time-consuming process where individuals had to conduct in-depth research themselves. However, due to the increasing demand for ethical investments, collections of ethical investments have been released which in theory should make buying combinations of ethical investments much simpler. A 2020 report by the International Institute for Sustainable Development (IISD) noted that younger generations are not only more likely to invest their earnings than previous generations, but that they are savvier with their choices. The IISD describes how these young investors were more likely to fund sectors and entities they identify with – leading the think tank to predict high growth opportunities for companies embracing sustainability.
Investors can choose investment products that utilise ESG criteria from brokerage firms, mutual fund companies and Robo-advisors. ESG investing also incorporates positive screening. By choosing investment products that utilise ESG criteria, investors can be more confident that the companies they are investing in are having a positive impact. This is an additional factor than choosing not to invest in businesses that have negative business practices. It also means that investors can feel assured that they are helping to support businesses that they believe are doing good in the world.
A positive bottom line for both investors and the planet
These ESG investment funds are seeing massive growth and have huge long-term potential. For example, the Report on US Sustainable and Impact Investing Trends 2020 (US SIF Foundation) using data tracked to the end of 2019, “found that investors are considering environmental, social and governance (ESG) factors across $17 trillion of professionally managed assets, a 42 per cent increase since 2018,” as they go on to explain, this increase is set to grow, “This is a continuation of the significant growth in money managers and institutional investors that consider ESG factors to identify responsible, well-managed companies that will be resilient over the long term”.
US sustainable investment has had a compound annual growth rate of 14 per cent since 1995 when the US SIF Foundation began measuring it. The speed of this growth has increased most rapidly since 2012. Of the $51.4 trillion in total US assets under professional management, sustainable investing accounts for 33 per cent (US SIF Foundation, 2020). If this type of investment continues to follow this trend it is set to capture an ever-greater proportion of the US investment market. As its popularity rapidly grows, ideally so will its positive impact. This growth is certainly not consigned to the US though.
In BNP Paribas’s ESG Global Survey 2019 “about 75% of asset owners and 62% of asset managers surveyed allocated more than a quarter of their funds towards ESG, up from about 50% in 2017”. Regionally, Asia Pacific has been integrating ESG investments at the highest level. “55% of respondents from the region are looking to park at least half of their investments in funds incorporating ESG, compared to 49% globally” (ESG Global Survey 2019).
Additionally, the Global Sustainable Investment Review 2018 conducted by the Global Sustainable Investment Alliance (GSIA) states that the “sustainable investment market has continued to grow and evolve globally. While each region’s approach to sustainable investment is slightly different, some trends have had a global reach. Every region again saw a rise in ESG integration and sustainability themed investing”. The GSIA biennial reviews were started in 2012 and take into account regional sustainable investment data from Europe, the United States, Japan, Canada, and Australia and New Zealand.
What does this mean for global islands, and how is it set to benefit them?
The rise of ESG investments is expected to have a positive effect on how global decision-makers operate – whether it be via business or policy, ESG represents the next step in sustainability. By prioritizing solutions that are good for both the environment and the economy, it opens more opportunities for local entrepreneurs to shine through with their own solutions, and potentially find avenues for funding that may not have been there prior to the popularization of ESG. This provides direct economic benefits to island communities, some of which will be discussed in-depth at the upcoming Island Finance Forum (IFF), but also has the potential to help mitigate the impacts of climate change, which disproportionately affects island and coastal communities. The combination of increased social pressure, the public’s willingness to financially support sustainable business models, and the ongoing global push for responsible climate policy, are creating an environment in which ESG can thrive.
Of course, one should not forget that ESG investments are not only beneficial in terms of being a good financial investment for businesses and investors but also critical for the environmental health of the planet. The financial gain from ESG investing should be of secondary importance to the major sustainability and ethical gains that it brings. Investors increasingly want to invest in companies that are doing good for people and the planet. As this momentum continues to grow, this will lead to increasing numbers of businesses enacting changes that align with the ethical and environmental criteria of investors and consumers. For example, many major corporations have recently announced their plans to become carbon neutral in the next two decades including Starbucks, Microsoft, Apple, Amazon and Unilever. This exemplifies the potential behind ESG, and how it can have significant long-term benefits in the global fight against climate change – and island communities.
It’s clear that taking into account the ethical and sustainable demands of investors is good for business. Doing good is becoming highly profitable, rather than being a cost. Examples of this are the growing demand for renewable energy such as solar and wind and electric vehicles such as cars produced by Tesla. Another is the growth in vegan/plant-based diets. “The global vegan food market size was valued at USD 12.69 billion in 2018 and is projected to expand at a Compound annual growth rate (CAGR) of 9.6% from 2019 to 2025” (Grand View Research). To learn more about how ESG and impact investing can potentially drive the sustainable and green economic growth of island communities, there will be a session entitled “Impact Investing and ESG – An Opportunity for Financing Sustainable Development on Islands?” at the Island Finance Forum (13th-16th April) which you can register for here.
Importance of ESG investing
Major corporations and governments have often had issues regarding their actions or investments and how they may betray a short-term bottom-line approach rather than a sustainable long-term solution. Where the populace at large was once less informed of how our actions can impact the planet, they have become more aware and ready to advocate for a transition towards a better economic model.
This has led to a corresponding shift among decision-makers, who are now more likely to be held accountable for their decisions regarding investments, their environmental impact, treatment of their workforce – this is where ESG enters the fray. Business owners are becoming aware that it is vital to factor in environmental and worker protections. They also know that they need to change their governance structures and lead in more fair and inclusive ways. ESG investing and other forms of sustainable and ethical investing is leading to fundamental change.
Aligning investment to SDGs
ESG investing makes it much easier for investors to invest in businesses that are both doing good in the world and avoiding harm. It is encouraging to see that investment frameworks are becoming more strongly aligned with the United Nations Sustainable Development Goals (SDGs). The rapid and continuing growth of ESG investing will be vital for the successful realisation of the UN SDGs. This includes gender equality (Goal 5), affordable and clean energy (Goal 7), decent work and economic growth (Goal 8), responsible consumption and production (Goal 12), climate action (Goal 13).
If business were to carry on as it has done until very recently, it would be almost impossible to achieve the majority of the SDGs by 2030 People and the planet’s resources were being exploited across the world in the name of profit. Greed was almost viewed as good, despite all the destruction it was causing. This isn’t to say that the profit motives of many business owners have gone away, but rather they are beginning to acknowledge the potential and benefits of a greener economic model. Now though, investors care about and can choose ESG investing, so many corporate leaders have no choice but to change. If they don’t, they risk facing a backlash from ethically-minded investors.
This is good news for those choosing an ESG investment strategy. As demand grows for products and services created by companies doing good, investors will achieve higher returns. According to the BNP Paribas ESG Global Survey 2019 “More than half (52%) of respondents rank improved long-term returns as the top reason for incorporating ESG in investment decisions, with 60% expecting their ESG portfolios to outperform over the next five years”.
Hidden problems within ESG investments
ESG investments are not without their issues. One of the major problems is that there are different ESG ratings agencies. There is not one standardised approach to ESG, but several methods of measurement.
As Investor’s Business Daily has pointed out, the variations in methodologies can cause a major problem. Between the four main ratings agencies, MSCI ESG, Sustainalytics, RepRisk, and ISS, they found major inconsistencies. They found that each of these agencies uses their own metrics, weighting, methodologies and even definition of what counts as ESG. The result of this is that “a company may rate well below its peers according to one ratings agency while simultaneously out performing them according to another” (Investor’s Business Daily, 2018).
This suggests that rather than being a trustworthy investment strategy for those who want to invest in companies doing good, it is a system riddled with pitfalls. If there is no one standard agency measurement, how can ESG investments be truly trusted?
An even bigger issue is the fact that ESG ratings agencies may be failing to take into account differing international standards. This is why, according to Investor’s Business Daily, both BMW and Volkswagen both received higher ESG ratings than Tesla from Sustainalytics. This is despite both BMW and Volkswagen being embroiled in separate major scandals. By contrast, Tesla manufactures electric vehicles, solar panels and energy storage, with CO2 reduction embedded in its business ethos.
These issues and others undermine the very purpose of ESG investing and their positive impact. Investors may be led to invest in certain companies because of ESG ratings, despite major negative aspects to their business model, such as faking emission reductions. ESG investing could create the same problems for investors as company greenwashing does for consumers. They wish to do good but become confused by mixed messaging – the solution lies in more stringent monitoring, but also in ESG being more formally adopted within business structures, creating more competition and oversight.
Is ESG a ‘good’ investment?
Overall, despite the significant obstacles, ESG investing does appear to be generally positive. The growth in ESG investing has prompted company leaders to start to make changes that will please ethical investors. Ideally, this in turn means that the SDGs will become easier to achieve.
On the other hand, it is vital that the ESG investing framework is improved to become truly meaningful and effective. This will involve standardising the system to remove the subjectivity and disparities that exist. Otherwise, while not useless, it could become more of a superficial badge that companies display as good PR, while not resulting in meaningful change. If this becomes apparent to the public, they may be put off from trying to invest in companies doing good which would be a tremendous shame.
For companies, incorporating positive ESG changes will become increasingly profitable in the long term, especially if investors have full confidence in the ratings system. There is ample evidence that due to the widespread international growth in ethical and environmental consciousness, that ESG investments are set to increasingly be the investment option of choice. From a business perspective, therefore, it makes perfect sense to make these positive alterations to attract more investors. If not, companies face a growing risk of losing to their competitors that do take into consideration the transition in public moral sentiment.
From the perspective of island stakeholders, the growth in ESG investing represents a potentially very positive shift. It will ideally mean that business leaders will start to enact a whole host of changes that will benefit island communities, leading to the possibility of more environmental sustainability and improved quality of life. This could include the transition away from single-use plastic, the move towards the widespread use of renewable energy and more equal gender and racial representation within company leadership roles. As well as benefiting the lives of island residents, island business owners that incorporate ESG changes into their operations will also start to reap the benefits of increased investment.
To find out more about ESG investing make sure to register for the Island Finance Forum 2021. There will be a session called ‘Impact Investing and ESG – An Opportunity for Financing Sustainable Development on Islands?’ Register for the Island Finance Forum 2021 for free here.