When ESG, the catch-all acronym for environmental, social and governance, is discussed, a lot of terms are thrown around. As these issues increasingly play into institutional investors’ decision-making, they need to know what it all means.
Climate change dominates among environmental concerns, but plastic waste is also holding investor attention. Major social issues include preventing sexual harassment, the ethics of owning private prisons and gun violence. On governance, investors are paying attention to diversity on corporate boards, as well as the ramifications of scandals involving company executives.
Define your terms
For institutional investors, the two traditional motivations for using ESG are affecting positive change and mitigating the risk associated with a relevant issue, although one investment can have the capacity to do both.
According to a 2018 study by RBC Global Asset Management Inc., 54 per cent of institutional investors said they use ESG because they consider it part of their fiduciary duty, followed by the beliefs it lowers risk and increases returns (53 per cent) and is a source of alpha (38 per cent).
“It’s not because we’re tree-huggers,” says Gordon Power, owner and chief investment officer at Earth Capital Partners, a private equity firm focused on sustainable investments. “If your business is sustainable, it tends to be worth more.”
However, given the myriad issues falling under the ESG umbrella, the approaches taken by investors can vary considerably. “Everyone has their own religion when it comes to ESG,” says Bernard Sabrier, group chairman of Unigestion and chief executive officer of Unigestion Asia.
Within Unigestion’s asset management business, the practical application of ESG can mean different things, he notes. “[Clients] have different objectives. Some will say, ‘No arms. No tobacco.’ Another will say, ‘No uranium.’ We are asked to give carbon footprints by some, while some are less interested.”
No matter the issue, ESG begins with whether or not to make an investment and, if so, what that ownership looks like. In terms of divestment, some do it strictly on an ideological basis. But when an investor is a fiduciary, like a pension fund, doing so can be both logically and legally problematic. More often, an investor will divest when an ESG problem is going to, realistically, make an investment too risky.
The opposite side of that spectrum is engagement with investee companies. Investors might simply discuss an issue with a company’s executives, or they may call a shareholder vote to nudge a company in a desired direction. These votes are becoming more popular. A 2018 report by Edelman found 91 per cent of Canadian institutional investors have changed their voting policies to be more attentive to ESG, with 65 per cent doing so in the previous year.
Impact while you work
No matter how they allocate, investors make an impression on the world, says Power, noting they must consider the interconnectivity of diverse ESG issues to see an accurate picture of this impact.
For example, shareholders may vote to replace the toilets in an office building with low-flow options to use less water. However, many people don’t realize the ceramics industry is very carbon-intensive, so making that choice comes with a trade-off, says Power.
It can be difficult to understand the limitless potential trade-offs that accompany any allocation, he says. To standardize this thought process, many investors have started using the United Nations’ goals for sustainable development. Indeed, 65 per cent of asset owners and money managers said their investment strategies are aligned with the U.N. goals, according to a 2019 survey by BNP Paribas Securities Services.
Measuring an investment’s opportunities and risks based on the goals can suss out any trade-offs, says Power. For example, while an investment may rank highly on helping to reduce poverty, it may also rank very low on responsible consumption and production.
Martha Porado is an associate editor at Benefits Canada.