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  • Environmental, social and corporate governance. Or E.S.G.

  • These are the trendiest words in finance.

  • Supporters say that being ethical and being profitable need not be mutually exclusive,

  • benefitting stakeholders, society and the planet.

  • But critics argue that these products are not that different from other investments,

  • and complain that it can be hard to measure  whether a company is actually doing the right thing.

  • So, is ESG just good branding?

  • The idea of investing based on a set of principles,

  • and not merely for profits, is as old as the concept of investing itself.

  • In the 18th Century, Christian groups such as the Methodists and Quakers articulated this idea

  • with clear guidelines to their followers, and it has been gaining ground ever since.

  • The pressure to avoid giving capital to South African companies between the 1970s and 1990s

  • is seen as a factor that contributed to the end of apartheid.

  • More recently, the impact of our day-to-day lives on the environment has been the center of attention.

  • And that is affecting how investors allocate their money.

  • There is this increasing understanding in society that we need to care about the climate,

  • about social conditions of employees, so this has shifted the focus also

  • of the investment management industry. And second, the understanding based on academic research

  • that if you integrate ESG factors, you can generate higher performance and lower risk.

  • This awareness has led fund managers to create financial products which invest

  • in companies that meet their criteria of being ESG-friendly.

  • And more investors are adding ESG funds to their portfolios.

  • The share of global investors that applied ESG criteria to at least a quarter of their total investments

  • jumped from 48% in 2017 to 75% in 2019.

  • In the U.S., professional investors are expected to expand their holdings of ESG assets

  • from $12 trillion in 2018 to $35 trillion by 2025, or 50% of their total investments.

  • These numbers were calculated before the coronavirus pandemic,

  • but the health emergency could further accelerate this trend.

  • Has Covid in a way impacted this interest in ESG in any way?

  • Do you think it could actually make investors even more interested?

  • Absolutely yes, it's certainly served to elevate and really put a spotlight on the way companies operate.

  • This emphasis that we have been hearing about for some time, this idea of corporate purpose,

  • you know, intentionally contemplating the needs of a broader universe of stakeholders,

  • broadening the aperture of how you think about enterprise risk, opportunity, disruptions

  • that could compromise your ability to meet your strategic objectives.

  • And Covid has certainly put that sort of set of considerations in the spotlight.

  • So, how does an ESG fund actually work?

  • The principles of ESG are really an underpinning for how stocks are selected.

  • Looking at 'G', the governance, of how the management of those companies works.

  • Looking at the 'S' has become incredibly important during the pandemic,

  • thinking about how the company is interacting with all its stakeholders,

  • including the communities it operates in and its employees.

  • And then the environment and environmental policies and actions by companies.

  • So really, it's become a much more thorough and integrated part of the evaluation of companies

  • that get put into portfolios that become ESG funds.

  • The investment profiles of the world's four biggest ESG funds have changed over time.

  • For instance, about a decade agothey included substantial stakes in major oil firms.

  • In 2007, the largest ESG fund had almost 13% of its total investments in companies

  • such as Royal Dutch Shell, Total and ExxonMobil.

  • But this has fallen in the years since, and the share of oil companies featured

  • in this particular ESG fund's holdings has shrunk to less than 3% as of July 2020.

  • But how can funds that claim  to promote sustainability 

  • ever support oil firms,

  • which are widely seen as responsible for soaring levels of pollution?

  • When you think about the composition of ESG funds it's first of all important to remember

  • they are still meant to be a fund invested to get a return for the portfolio

  • and so they can tilt based on industry groups, based on sector views

  • and that may or may not relate to an ESG view.

  • Ultimately, ESG funds, like all other investments, are meant to generate profits.

  • In fact, ESG funds have slightly outperformed other funds over the last two years,

  • at least in part thanks to their holding of tech stocks which have rallied strongly.

  • But a portfolio manager told us investors need to think about returns in the long-term.

  • As a believer of ESG as a firm, I like to read all these articles,

  • but I think it is a bit of bias in terms of the analysis simply because these ESG products,

  • they have lower energy exposure, and the energy sector was hard hit this year because of Covid.

  • On the other side, many of the tech companies, they get a high ESG score because they had already in place,

  • you know, working from home policy, they are more keen in terms of, you know,

  • taking care of their employees because that's what they have, right, all of these tech companies, so they score high.

  • Since 2010, the fourth-largest ESG fund in the world has increased

  • its exposure to tech giants from about 8% to more than 17% within a decade.

  • Online retail giant Amazon was one of these big tech firms seen as ESG-friendly,

  • even though the company registered a carbon footprint of over 50 million metric tons of CO2 in 2019.

  • And with emissions rising by 15% compared to the previous year, the environmental concerns aren't going away.

  • We don't have clear standards on what is good, what is bad in terms of ESG.

  • Which also means that for investors looking into these funds, they need to look carefully at how they define it.

  • So if you look at Amazon as an example, maybe one fund says they are doing a fantastic job in terms of ESG

  • and another one may say, 'well we disagree,' but because there are not these obvious standards,

  • you know, you see even in high ESG funds, very different portfolio shares of firms like Amazon.

  • In the case of Amazon, its commitment to reduce its carbon emissions and become carbon neutral by 2040

  • is seen by some asset managers as a reason why the stock meets the definition of being ESG-friendly.

  • We could look at companies and say 'your carbon footprint today is not satisfactory'.

  • The old way that investors addressed that was often by taking their money out of those companies.

  • Today divestment isn't seen as the optimal way to push for change.

  • Engagement and stewardship by investing and asking for a clear timeline for improvements

  • in things like carbon footprints is a much more, we will call it 2.0 way,

  • of thinking about using capital in the ESG space.

  • These subjective judgments  give rise to another criticism 

  • leveled at ESG investingit often lacks transparency.

  • We look, at a company level, at about just over a thousand different data points,

  • and when I say a thousand different data points, this is what we really look for companies to publish.

  • Now what we observe is that companies don't publish all of those data points

  • and actually how much of their data is published in itself

  • tells us a number of important insights into how companies implement ESG.

  • Do you care about a carbon footprint of a particular company?

  • Absolutely. So, the carbon footprint comes actually in at several levels.

  • Because one of the things we are very conscious of is when people can, or companies can very much

  • hide their carbon footprint by outsourcing certain parts of their production process

  • to other companies or other jurisdictions and that in itself is not a good,

  • not a good sign, not a good thing.

  • Organizations such as the United Nations and the European Commission

  • are promoting common standards to address these concerns.

  • At the moment, some feel  there's not enough disclosure 

  • from fund managers about why their products should be considered ESG-friendly

  • Investors may also need to  do some more background work

  • to ensure they're putting their money in funds that meet their ethical objectives.

  • And this is where further regulation could add some more clarity.

  • We've largely seen the regulatory momentum taking place in Europe.

  • We're starting to see some momentum in the U.S., but I do think that U.S. companies,

  • absent regulation, are not waiting. And I think companies certainly see

  • that there are broader global trends, there's opportunity, this is not going to be just a compliance exercise.

  • Hi everyone. Thank you so much for watching.

  • Would you invest in an ESG fund? Let us know in the comments section

  • and don't forget to subscribe. I'll see you soon.

Environmental, social and corporate governance. Or E.S.G.

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    Summer posted on 2020/10/14
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