ESG, or Environmental, Social and Governance, refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business, and these criteria help to better determine the future financial performance of companies. As part of the investment and decision-making processes, responsible investing is necessary, with ESG factors looking at certain areas that traditionally aren’t part of financial analysis, but could have financial relevance. How workers are treated, what is their health and safety policy and how effective is it, do they take climate change into account all fall into this bracket.
It’s estimated that a quarter of all professionally managed assets around the world have some form of ESG investment, totalling over $20 trillion in AUM (Assets Under Management). Investment is based on the assumption that ESG factors have financial relevance, and a larger number of investors recognise that ESG information is required to understand the strategy and management quality of companies amongst other things.
As with many new concepts, investors were initially and understandably reluctant to embrace ESG, and even now there are some arguments against it are still being made. However, the evidence continues to point to its importance and it’s seen increasingly as part of fiduciary duty.
There has been a steady improvement in corporate disclosure, with the initial lack of data and fragmented information seemingly now overcome. Today, 80% of the world’s largest corporations use Global Reporting Initiative standards and, overall, the market for ESG information is maturing and getting better all the time. Machine learning as well as big data can unlock valuable insights and offer easier ways to apply ESG data in addition to conventional financial information.
The idea that investors who integrate corporate environmental, social and governance risks can improve returns is now rapidly spreading across capital markets on all continents and the community for global investment has developed a variety of methods to integrate ESG information. Of course, there will always be those who will suggest that such investment is nothing more than a gimmick, but the market growth would suggest otherwise.
Cynics may argue that responsible investing is just a fad. But a closer look at the forces that have driven the movement over the past 15 years suggests otherwise. Processing data will become cheaper and easier with algorithms able to interpret the volume of non-traditional financial information quicker and more accurately.
ESG investing will allow those empowered by technology to ensure that there are savings to be made and premiums on good stewardship and low carbon practices as natural assets will appreciate in value over time. The biggest challenge of course, for companies that is, is to adapt to this new way of working. As corporations and investors experience growing influence and power, their actions and decisions increasingly shape the future. ESG data has therefore become much more important in order to identify those who favour a smarter, healthier and cleaner working environment.