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The deep dive: It’s an ESG wrap

The deep dive: It’s an ESG wrap

By now the three holy grail letters of conscious investing should be second nature to you guys, but don’t worry if not. In this deep dive — the last of our four-part series on the conscious investing space — we’ll be doing a quick recap (with the help of an example) while also taking a closer look at the MENA ESG landscape.

We’ve established already that when it comes to compiling a consciously-minded portfolio, it’s a case of deciding what our desired areas of impact are. But, where does someone go from there? We’re going to take one or more values, as an example, and then move forward to see how to end up finally making a conscious investment. We’ll start off with, for instance, by saying that a conscious investor — we’ll call them Alia — wakes up one day and decides that they care about climate change… 

Industries and Instruments

Alia’s done with the most important step of the process, which is to come to a broad understanding of what she cares about. We’ve obviously simplified that by coming up with a focus area for her, but ideally someone would take a little bit more time to decide on the impact area(s) they align with the most. 

Now it becomes a case of which industries we actually want to target? Climate change is too broad and there are different industries that are working to combat it in various ways. While we know that it sits under the ‘E’ component, industries linked to climate change include agriculture, technology, clothing, energy, and aviation, among others. It’s up to traders to determine how broad they want to keep their investments, or whether they want to focus on a few particular industries linked to their issue. Let’s say, through some research, Alia finds that 70-80% of greenhouse gas emissions (a main cause for climate change) originate from energy production. This is quite a large percentage, and it prompts her to think about potential investments in the renewable energy sector.

With a broad focus area (climate change) and a particular industry (renewable energy) set, Alia can finally think about which financial instrument she wants to invest through. Is she looking to compile a portfolio of individual companies (i.e. stocks), or does she want to make sure she’s giving her money to a larger set of renewable energy firms all at once by investing in an ETF? Or perhaps a mixture of the two? It could be that she comes across a really cool solar energy firm, like First Solar (FSLR) which makes innovative thin-film solar panels capable of high energy production. Because of her interest in the company, Alia makes sure to include it into her portfolio.

But beyond a few specific businesses like First Solar, she could be indifferent as to which particular stocks she’s investing in. In that case, the rest of her allocation could go towards ETFs with a high number of renewable energy stocks or even non-climate stocks with high ‘E’ ratings. Each ETF offers a prospectus for her to see each company the fund invests in, while non-climate equities like tech stocks have ‘E’ elements such as solar-powered data centers.

While Alia might be sure that she wants to target funds or stocks with a green energy focus (i.e positive screening), it could also be the case that she wants to avoid certain stocks (i.e. negative screening). She might not be a big fan of investing in a coal mining company alongside a wind turbine manufacturer, since both of them have opposing aims.

The same process can be applied to funds as individual retail investors can use virtual ESG screening tools with filters to see how different ETFs rank against each other and whether any include non-preferred stock holdings. There are also thematic offerings from retail trading platforms. This is when some platforms compile a list of hand-picked, sustainability-focused stocks – all laid out in an easy-to-understand way so investors can choose whether or not to allocate their money towards them. 

Testing your ‘impact’ threshold

Alright, we’ve decided upon an industry and we have a clear idea of the type of financial instruments we could target. Now comes the fun part: doing some digging around to pick which specific stocks or ETFs we want in our portfolio. 

This involves Alia deciding where she lies on the impact spectrum. Do returns matter to her more than the level of impact she’s facilitating through her investments? Are there certain conditions she’s put in place for her portfolio? Some investors might only be concerned about returns to the extent that they’re able to get their original amount (i.e. principal) back, while others might, on top of a returns target, also be more focused on picking ESG companies that are solving specific problems. It’s important to realize that this is not an all-in approach of zero return or zero impact — high ESG scores and top returns are often complementary instead of substitutive. 

The spectrum is more about the desired level of impact you want to achieve through the investments, with returns still being factored in at each stage of the conscious investing process. The key difference from a traditional retail investing strategy is that conscious investors take a holistic view of the company — and from that may decide to exclude certain equities that have high returns but a low impact element. Alia might decide, for instance, that since she’s picking an industry like renewable energy, which has the ‘impact’ element explicitly embedded into its business model. So, she’s less keen on letting her portfolio consist of non-renewable energy stocks even though they have high returns. 

Picking which particular stocks/ETFs align with your ‘impact’ threshold can be done through the various ESG ranking metrics out there. Companies like MSCI Inc (MSCI) and Morningstar (MORN) regularly release ranking guidelines and key industry reports on the ESG market which are incredibly useful as a starting point for conscious investors. There should also be a bit of personal web-sleuthing when it comes to picking ESG companies, as rankings might not be entirely accurate. It could be that a company with great governance and social metrics ranks highly overall but its environmental initiatives aren’t all too rigorous.

In addition, it’s important to realize that returns are still an important part of the investing equation. And picking stocks that align with your return goals is the same as the standard stock-picking process where you research the company’s business model, earnings reports, and key financial metrics like revenue or net income.   

As DIY trading platforms crop up and the conscious investing market grows, we could start to see investors pushing companies to disclose more ESG-related metrics in the same way that businesses already report things like an income statement or cash flows.

ESG closer to home

While it might be hard to see ESG playing out in the MENA region, elements of it do exist. The GCC’s Vision 2030s, for example, have a huge diversification aim that involves reducing oil dependency. This has led to large-scale sustainable urban planning projects like the $500b megacity NEOM or previously state-owned oil companies, like Aramco, going through denationalization.  

In recent years, there’s also been a significant push towards sustainable debt financing (green bonds). This is the issuance of debt primarily meant to be used for sustainability or green energy projects. In the first half of 2021, green debt issuances in MENA reached almost $6.4b — already exceeding last year’s total. The Arab Petroleum Investments Corporation’s (APICORP) $750m green debt issuance in early October also marked the first green bond released by an energy-oriented financing institution.

As (green) debt and diversification grow in the region, the sustainability push from governments and financiers at the top could eventually start to filter down to individual companies.

why it matters

A sample walkthrough of what making a conscious investment looks like on a retail-investor level shows us how customizable the whole process is. Ultimately, conscious investing is less a virtue-signalling device and instead slowly becoming the status quo as the intersection between high ESG rankings and top financial returns grows day by day.