By: Anne Fang & Brandon Mundl
ESG factors are becoming increasingly important in the field of investments as investors start to focus on sustainability. If a company is strong from each of the standpoints of Environmental, Social, and Governance, it can be considered sustainable. Today’s blog will introduce the status quo of ESG guidelines and touch on the increasingly dominant role that ESG plays in the investment world.
How does ESG play a role in investor sentiment?
The Principles for Responsible Investment (PRI) was launched in 2006 with 63 investment companies and there are now over 4000 investment companies who have made the commitment to incorporate ESG issues into their investment decisions. In 2020, record amounts of money flowed into ESG funds. Precisely, these funds received over $51.1 billion in new investments last year. Investment companies have begun to place more importance on ESG factors because alongside their clients, these funds want to invest in companies that care about the environment, are socially responsible, and have executives and directors who have the best interests of shareholders in mind. Although these are known as ESG factors, they can be seen simply as attributes of a good business. For example, the Caisse de Dépôt et Placement du Québec (CDPQ), a large pension fund, recently made a commitment to exit investments in oil producers by the end of 2022 and it set up a $10 billion transition fund for companies in high pollution industries who are committed to achieving net-zero goals, achieve certification from independent organizations, and publish annual reports on their decarbonization. This commitment demonstrates the growing importance of ESG factors in the minds of investors. This increase in importance has led to more activism on the ESG front and companies are starting to take these factors into consideration.
How would ESG guidelines affect companies’ actions and decisions?
It is evident that companies hope to attract investors, and as more and more investors start to pay attention to corporations’ ESG commitment, many businesses have shifted a large part of their focus into ESG initiatives. As of July 2020, 90% of S&P 500 corporations have released at least once in their annual corporate report their sustainability and ESG practices efforts. Transparency on social and environmental issues will be a top priority for companies in the future years. According to Deloitte Center for Financial Services, investors are increasingly considering ESG issues to manage investment risks.
So what does this mean for companies in the future? Strong ESG practices and reporting will bring a positive competitive advantage to companies. Although no law or regulation enforces mandatory ESG reporting, forward-thinking companies voluntarily disclose ESG criteria in their annual reports. They understand the increasing importance of including sustainability criteria in their strategies and purposes. These ESG reports often tend to showcase companies’ humane and ethical side, proving they hope to generate more than simply financial return. A company with good ESG performance receives preferential treatment from investors compared to companies with poor ESG practices. For instance, during the early 2010s, Apple’s inhumane working treatment and horrible working conditions in factories of developing countries made the stock drop more than 5% in a day. One question that is often raised is whether companies can secure a financial bottom line along with keeping up good ESG practices. However, ESG factors are often viewed as a risk management tool for investors, as they believe that ESG practices ensure long-term sustainability and stability of business operations, providing financial security for investors looking for value investments.
While there still exists controversies about whether the focus on ESG will deviate from companies’ financial bottom line or short-term gain, it is undeniable that the disclosure of ESG reports and investor’s monitor on companies’ actions can help to ensure a more sustainable and humane way of practicing business.