CO2 emissions, social dialogue, or the inclusion of more women on boards of directors... The well-known ESG acronym refers to the environmental, social and good governance criteria used to analyse and evaluate the extent to which companies integrate sustainable development issues into their strategy. It covers the aspects likely to have an impact on society or the environment and is used to measure the sustainability and ethical soundness of an investment within a company. Nonetheless, the good news is that these investments do not underperform conventional investments!
Environmental, Social and Governance (ESG) criteria are used to assess a company's societal contribution with regard to their stakeholders (employees, partners, subcontractors and customers) and the environment. They also serve to guide and structure the analysis of a company’s financial performance.
When a company implements a CSR approach, from that point on, its financial performance will be linked to its environmental and social impact.
What exactly do the three ESG criteria cover?
The first attempt to evaluate companies and financial securities dates back to the 1990s. In 1995, the entrepreneur John Elkington explained that a company should regard the “three Ps” (“people, planet and profit”) as equally important for the long-term success of the business. This concept was revised by the financial sector, resulting in the environmental, social and governance (ESG) criteria, which now form the basis of the majority of sustainable investment processes.
The way in which assets are selected according to the ESG criteria varies from one company to another. Each rating agency (among the most reputable French companies: Vigeo, Ethifinance, Innovest and BMJ CoreRating) or management company relies on its own methodology and measurement indicators to choose ESG investments. In this case, the aim is not to assess a company's ability to repay its debt, but to assess its potential to create value in a sustainable way.
💡 Note: certain rating agencies specialise in one of these three criteria.
Nevertheless, certain common practices can be applied to classify companies and investment funds into their respective categories.
There are two possible approaches for establishing this hierarchy of companies:
Today in France, ESG portfolios are becoming increasingly attractive: according to a study conducted in 2019, 61% of savers say they consider the environmental and social impact to be important when making investment decisions (source: Ifop survey for FIR and VigeoEiris). Some of the subjects deemed priority issues by the respondents are as follows: protection of jobs, pollution and human rights.
However, before taking the plunge and making ethical and sustainable investments, it is advisable to bear certain information in mind to avoid some of the most common mistakes.
Before investing your hard-earned cash, you should carefully refine your investment strategy to avoid going back on your good intentions and being majorly disappointed. The aim is to combine financial performance and positive societal impact while avoiding the pitfalls of ESG classification.
For example, a stock based on gold mining may be identified as being a good ESG investment because it scores highly in terms of favourable working conditions, while the mining industry is considered very harmful to the environment based on the technologies used, leading to pollution and the destruction of biodiversity.
For example, on the other side of the Atlantic, the policy of unlimited energy based on the exploitation of fossil fuels does not necessarily affect a good rating.
How are SRI funds connected to ESG? SRI (Socially Responsible Investment or ISR in French for Investissement Socialement Responsable) funds have been awarded the ISR label, created in 2016 and promoted by the French Ministry of Finance. The aim of the label is to make it easier to find socially responsible products in Europe.
Internationally, index providers (FTSE Russell, MSCI, etc.) produce stock market indices based on ESG criteria, thus allowing index fund providers (an investment fund that aims to replicate the performance of a stock market index) to offer investment vehicles based on these same supports.
More cautious investors are bound to wonder: are sustainable investments less profitable?
This is simply not true since companies that have invested in sustainable development are not less financially successful than others. On the contrary!
First and foremost, these investments are less volatile.
Studies show that companies aligned with ESG criteria perform an exceptional feat: they are less expensive to finance while being less subject to price volatility. This leads to the conclusion that investing in predominantly ESG portfolios reduces exposure to risk while boosting performance.
Deutsche Bank and the University of Hamburg reached this same conclusion after compiling more than 2,200 studies published since the 1970s: according to their research, in 90% of cases, there is no negative correlation between compliance with ESG criteria and portfolio performance. On the contrary, the correlation is positive, which appears to confirm the financial benefits of SRI investments.
Has the desire to do the right thing spread to the world of finance? It would seem so! 65% of investors incorporate ESG components with their main aim being to have a positive impact on society (source: survey conducted by the EDHEC-Risk Institute involving 191 participants in 29 European countries).
Ultimately, ESG criteria are applied without sacrificing financial performance to make meaningful investments by sometimes financing businesses which offer solutions and responses to major societal issues.
🇫🇷Note: the idea of what constitutes a positive impact on society varies from country to country. Approaches differ in Europe and throughout the world, depending on the local culture. For example, in France, we tend to prioritise social issues, Switzerland and Germany are more focused on the environment, Great Britain is more interested in governance, and the Scandinavian countries and the United States are most concerned with ethical values.
Obviously, society’s new appetite for sustainable development is having an impact on SMEs and large companies.
For investors, the integration of environmental, social and governance (ESG) criteria is becoming increasingly attractive: with 78% stating that the ESG factor now plays a growing or dominant role in their investment strategy (source: survey conducted by BNP Paribas involving 347 asset owners and managers across Europe, Asia and North America). Along the same lines, the report states that 65% of respondents aligned their investment strategy with the United Nations Sustainable Development Goals (SDGs): “More and more asset owners and managers see responsible investment as a way of making a positive contribution to the SDGs.”
Thus, long-term returns are the primary motivation for 52% of investors, followed by risk reduction (37%).
It should be noted that investors still face major obstacles, in particular, a lack of data: 20% of investors explained that they do not align their investment strategies with the SDGs due to a lack of information and reliable data.
Furthermore, investors would also like to see ESG criteria better integrated into different investment vehicles, such as smart beta or multi-factor strategies (source: survey conducted by the EDHEC-Risk Institute).
They are also keen to see the development of more tailor-made solutions. Therefore, if they wish to attract more investors in the future, researchers and solution providers will have to integrate ESG criteria more fully into their products.
30% rely on a themed approach, and only 25% use negative screening, i.e. eliminating certain sectors of activity altogether.
Over the years, successive surveys have shown that ETFs have been widely adopted in order to invest in the main asset classes. In 2020, 92% of respondents used ETFs to invest in equities and 97% were satisfied with this choice, a situation that has remained fairly stable over the past decade. More recently, the use of ETFs for ESG investing is becoming more common.
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