Those who ig­nore ESG trend could lose out on mil­len­nial boom

Sunday Independent (Ireland) - Business & Appointments - - FRONT PAGE - Brian Flavin

EN­VI­RON­MEN­TAL, so­cial and gov­er­nance (ESG) in­vest­ing has ar­guably reached a point where it is too im­por­tant for in­vestors to ig­nore. This type of in­vest­ing is about us­ing th­ese three im­por­tant cri­te­ria as fac­tors to make in­vest­ment de­ci­sions.

It is be­ing driven by a shift in at­ti­tudes to­wards a de­sire for re­turns that ben­e­fit so­ci­ety as well as fi­nan­cial re­turns. Think emis­sion re­duc­tions, work­force di­ver­sity, work­force train­ing and de­vel­op­ment, board struc­tures, man­age­ment com­pen­sa­tion pol­icy, share­holder rights and busi­ness ethics for some of the more ob­vi­ous ex­am­ples. ESG in­vest­ing goes well be­yond so­cially re­spon­si­ble in­vest­ing, which sim­ply ex­cludes stocks or sec­tors from port­fo­lios be­cause of un­de­sir­able ac­tiv­i­ties or prod­ucts. ESG ap­plies to all sec­tors, and screens com­pa­nies that may score pos­i­tively or neg­a­tively on its met­rics.

To un­der­stand why in­ter­est in ESG has grown since the fi­nan­cial crash of 10 years ago, it’s in­ter­est­ing to ob­serve that, in the US dur­ing the pre-crash years, some of the largest banks would have seen a marked de­te­ri­o­ra­tion in their so­cial and gov­er­nance fac­tors, linked to is­sues like em­ploy­ment qual­ity, share­holder rights and man­age­ment com­pen­sa­tion poli­cies. Those that went bust would have been rated the worst, par­tic­u­larly for com­pen­sa­tion. Ire­land would not have been dis­sim­i­lar. There were some high-pro­file calls for less fi­nan­cial reg­u­la­tion here around the same time — and ex­ec­u­tive re­mu­ner­a­tion in bank­ing was high too. In th­ese cases at least, you could ar­gue that an in­vestor us­ing an ESG ap­proach to in­vest back then may well have avoided some of the dis­as­ters that fol­lowed.

Yet there is scep­ti­cism about the value of ESG to the in­vest­ment process. Can it re­ally lead to mean­ing­ful re­turns? As with most things in in­vest­ing, the an­swer is not black and white. Views dif­fer on what qual­i­fies as ESG char­ac­ter­is­tics, and so rat­ing providers use dif­fer­ent in­di­ca­tors and method­olo­gies. But there is ev­i­dence that ESG in­vest­ing is pos­si­ble with­out hit­ting per­for­mance. So, those who de­sire so­ci­etal and fi­nan­cial re­turns re­ally can have their cake and eat it.

The size of the in­vestor base set to in­te­grate ESG into their in­vest­ment prac­tices seems set to grow over the com­ing years. Eu­rope al­ready has a strong track record in val­ues-based in­vest­ing, helped by EU non-fi­nan­cial re­port­ing di­rec­tives. How­ever, it is in the US where the po­ten­tial for ESG in­vest­ing is great­est. More­over, it is thought that when the trans­fer of wealth from baby boomers to mil­len­ni­als starts around the late 2020s, tril­lions of dol­lars could flow into ESG in­vest­ments. That would be con­sis­tent with sur­veys of mil­len­nial at­ti­tudes to in­vest­ing.

There are many chal­lenges in in­te­grat­ing ESG fac­tors into in­vest­ment strate­gies. Com­pany re­port­ing with re­spect to ESG is­sues is in­con­sis­tent, as is the in­ter­pre­ta­tion of any such data. Sig­nif­i­cant knowl­edge of a sec­tor is re­quired. For ex­am­ple, a high-growth com­pany may not score well on gov­er­nance fac­tors, but that doesn’t nec­es­sar­ily mean it’s a bad in­vest­ment. It could be at a stage of its life cy­cle that re­quires greater fo­cus on sales than board struc­tures. No easy task then. Still, it seems that those in­vestors who ig­nore this ESG trend do so at their peril. Brian Flavin is se­nior eq­uity re­search an­a­lyst with Good­body (good­ Any in­vest­ment com­men­tary in this col­umn is from the au­thor di­rectly and should not be seen as a rec­om­men­da­tion from The Sun­day In­de­pen­dent

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