Open up a bog-standard college finance textbook, and you’ll find that there’s a number of goals every new investor should have in mind when entering the big and scary playground also known as The Market: maximize returns, minimize losses, grow your portfolio, and so on. But you’ll be hard-pressed to find nestled in that endless list of investor must-do’s, something related to making an impact, saving local communities, or backing diverse companies.
While most college textbooks might be out of touch, the modern-day investor isn’t – for them the ‘now’ is about conscious investing. Conscious investing is the idea that investors back a company for a reason that might be bigger than its latest earnings report, high-profit margins, and large market share. The modern-day conscious investor is now asking questions like does this company’s business model produce a positive societal and environmental impact, how does this firm treat its employees, and how diverse is its Board of Directors – questions beyond the one-dimensional profit angle. Over the past decade or so, conscious investing has sprung many investors concerned with questions of deeper importance like these, when compiling their portfolios.
Well, get ready for a morality check and more on how modern-day conscious investors are ingraining personal values into the trading arena! Because today we’ll be kicking off our new 4-part deep dive series on the world of conscious investing, the jargon that comes with it, and how each conscious investor’s questions of deeper importance are contextual to their own values.
Environment, Social, and Governance (ESG) – the conscious investor’s toolkit
From an investor’s perspective, ESG criteria is another set of metrics by which to judge the ‘ethical status’ of a company – and since investors are ultimately shareholders in the companies they invest in, what they’re judging a company by is important. In the context of the larger market, ESG criteria implies a shift in what a company’s main purpose should be. For a large part, most companies in the past operated with the goal to only maximize value for their shareholders, but in the last decade or so, most have added a broader purpose to their list: maximizing impact for all stakeholders in a business, whether that be through ESG practices or otherwise. This would mean considering how decisions affect your customers, suppliers, communities, and yes even shareholders.
But what is ESG? We’ve all heard ESG being thrown around in a company’s latest press release or annual report, but what does it even mean? Those three letters are a list of standards that conscious investors and companies use to measure how ‘socially responsible’ an investment or initiative is. ESG’s ‘environmental’ component looks at things like what a company’s carbon output is, its ‘social’ aspect might be concerned with how a company’s activities are affecting local communities, and its ‘governance’ criteria might scrutinize its relationship with shareholders. In some cases, ESG has become a catch-all term for anything that an investor deems as aligning with their personal values – it’s basically contextual.
Apart from ESG, you might also hear other terms such as sustainable investing, socially responsible investing, or even corporate social responsibility (CSR). Nvidia (NVDA), the US-based graphics card maker, for instance has an ESG-minded CSR division: it targets to source 65% of its global electricity from renewable energy by 2025. Similarly, Microsoft (MSFT) recently created a $1b Climate Innovation Fund to reach a ‘carbon negative’ status by 2030. Both of these initiatives would categorize themselves under ESG and have led both Microsoft and Nvidia to hold the highest ESG ratings according to the MSCI ESG Ranking (more on that later).
To understand what ESG’s benefits are, it’s also important to understand where it’s come from. Sustainability-oriented and conscious investing is a product of what an investor’s priorities are. As Gen-Zs/Millennials have become more socially aware aka woke, it seems natural for that to filter into their investment mindsets as well. The pressure for companies to adopt ESG frameworks comes from the people they’re targeting – if customers are becoming more principled, firms have to follow.
For investors, the benefits of ESG criteria involve having a standard by which to push businesses to align with their own values. For companies, it becomes a case of appeasing investors but also building initiatives that might be more lucrative for them. For instance, since 2019 European investors have funneled $142b into sustainable investments while research has found that S&P 500 companies ranked in the top 20% according to ESG metrics outperformed those in the bottom 20% in terms of financial returns. As ESG practices become more ingrained into the investing space, companies that adopt them have seen higher financial growth and less volatility – making the criteria a win-win for everyone.
ESG in Practice
Globally, the ESG markets have become increasingly institutionalized. Organizations like CDP Worldwide, for example, work with companies and cities to disclose their environmental impact on a regular basis for concerned investors to track their progress. Currently, over 9,600 companies disclose their data and practices to CDP across multiple climate change-related categories – including the likes of Hewlett Packard, L’Oréal, and Accenture. Even though there’s limited requirements from stock exchanges mandating the disclosure of ESG-related activities that a company is engaging in, investors are still able to utilize third-party rankings and voluntary disclosures. There are also already laws that exist in the EU to mandate these disclosures and ESG regulation is on the SEC’s agenda over the next year.
While, globally, ESG-driven conscious investing has progressed to the stage where regulators are talking about mandating sustainability disclosures, less-mature investing markets like the MENA region are catching the ‘impact’ bug as well. In 2020, financial lenders in the UAE, Egypt, Saudi Arabia, and Qatar all issued a collection of new ‘green bonds’: debt used to finance sustainability-related projects like clean transport and renewable energy. There currently exist 15 active MENA green bonds worth around $5b. ESG options at the retail investor-level are fast approaching in the region as well as the biggest stock exchange in the GCC, the Tadawul, plans to launch an ESG index this year. The index is set to include 70 Saudi-listed companies and Tadawul will also be releasing ESG guidelines for all listed companies. The UAE is hungry for that impact investing pie too – in 2020, 94% of UAE retail investors were interested in or using ESG criteria to pick stocks. The UAE’s Abu Dhabi Securities Exchange (ADX) is actually a step ahead of Saudi, already having launched ESG guidelines for companies to follow in 2019.
Plunging into the sustainability rabbit hole
You might be thinking – alright the whole making returns and impact at the same time is pretty dope but what’s in it for me? Well, for the retail investor picking out top-performing ESG companies is a matter of knowing where to look. And lucky for them, the ESG-stocks universe is expanding rapidly.
But before an investor jumps into looking at ESG metrics, it’s important to know what exactly you’re looking for – which impact-related issues are most relevant to you? Do you prefer to have a portfolio that’s heavily weighted towards companies with climate-positive practices? Do you instead align with companies that take diversity and inclusion practices while hiring seriously? Each conscious investor has a different set of ESG criteria important to them.
Once you’re clear on what matters to you the most, evaluating companies is a case of either digging through company disclosures (e.g. sustainability reports released by firms, annual CSR letters, etc) or using third-party neutral sources. When it comes to benchmarking, measures like the MSCI ESG Rating are incredibly useful. Developed by MSCI Inc., the system ranks equities and other financial instruments according to a standardized ESG measure. Each company is ranked across seven classifications from lowest to highest in terms of how ‘ESG’ a company is. Financial instruments like ESG ETFs, for example, offer conscious investors an opportunity to buy into a basket of stocks under one ticker – the EAFE MSCI iShares ETF (EFA) gives investors exposure to a pool of almost 850 sustainability-minded stocks, globally ranking it in the top 86th percentile of ESG ETFs.
Overall, as it stands right now ESG investing is a contextual process – it differs according to each investor. As stock exchanges begin to release ESG guidelines and industry regulators push to mandate those guidelines, that process could start to become a lot more standardized.
why it matters
Modern-day businesses are visible in almost every aspect of society – from our oil to our phones to our clothes, companies are at the middle of it all. It makes sense then that people who invest in companies and their customers are concerned with how that impact plays out beyond the world of profit and loss. ESG-driven conscious investing is a way to systematically build multidimensionality into your investing decisions – a way to allow profit and purpose to go hand in hand.