Economics versus Environment
Does responsible investing involve a trade-off between profits and sustainability?
SOCIALLY-responsible investing (SRI) and environmental, social and governance (ESG) principles are gaining a foothold in mainstream financial markets around the world. Asset owners and financial intermediaries increasingly seek to finance development that meets present needs without harming future generations. Globally, sustainable investments grew by a quarter over the last two years to US$23 trillion (RM91 trillion), according to the Global Sustainable Investment Alliance.
Nonetheless, there is still widespread debate among investors on whether the adoption of ESG policies would jeopardise their financial returns and lead to a trade-off in profitability. Although a growing body of literature suggests that ESG investing could improve financial performance, there have been equally contradictory statements issued by regulators and institutional investors that dismiss ESG’s claims to financial materiality. and higher economic performance or financial returns. For instance, The United States Department of Labor’s Employee Benefits Security Administration (EBSA) recently released a Field Assistance Bulletin advising fiduciaries of private-sector employee benefit plans to “avoid too readily treating ESG issues as being economically relevant to any particular investment choice” .
The EBSA’s guidelines were largely met with confusion from the US financial industry, as many investors felt that it adds to the misperception that sustainable investing strategies involved a trade-off in performance. But the Department of Labor is not alone in its skepticism about ESG. Even the Government Pension Fund of Norway, which holds about US$870 billion in funds, claimed that it has missed out on 1.1 per cent of additional gain due to the adoption of ESG criteria over the past 11 years.
Meanwhile, supporters of ESG cite numerous academic and industry studies in their argument that ESG is indeed positively correlated with enhanced financial performance. According to a research study by investment analyst MSCI, there is “strong evidence that companies with strong ESG profiles are really better at managing risks and opportunities”.
Another report by CDP North America, an organisation that collects environmental data disclosed by businesses, found that companies which scored highly on climate change management have also delivered higher returns on equity, reduced earnings volatility and shown stronger dividend growth compared to their lower-scoring peers.
This lack of consensus and competing investor opinions on ESG reveal a fundamental fact about the status quo: there is presently no objective and uniform industrywide framework to choose and evaluate the social or environmental impacts of ESG/SRI funds as well as their financial performance. The coverage and extrapolation methods used by ratings agencies to evaluate and assign ESG/SRI performance data have many gaps, yielding data that can be unreliable or industry-biased.
As a result, attempts to measure the “impact” of ESG principles have ended up being highly speculative and potentially misleading to investors. Asia is already known to be slower compared with other regional markets when it comes to the taking up of ESG investment strategies. A fuller, more universal ESG framework needs to be developed before investors could grow convinced about the environmental as well as financial positives
Regardless of the differences in opinion on whether ESG leads to a trade-off in profits, there is at least one thing that global investors can still agree upon: economic and environmental issues can no longer be treated as separate and distinct when it comes to making investment decisions. To put things into perspective, the value of global financial assets at risk from climate change has been estimated at US$2.5 trillion by the London School of Economics and US$4.2 trillion by The Economist.
Thus, climate-related risks are shared challenges faced by the whole financial community, providing the first basis for mutual investor cooperation and activism on the issue.
There is a clear need for investors to come together and reach a consensus on more objective, transparent, and universal standards for ESG. Investor anxieties about the trade-off between sustainability and profitability can only be resolved if better definitions and more transparent ESG metrics are developed to prove the impact of material ESG issues
With this in mind, the Kumpulan Wang Persaraan Diperbadankan (KWAP), Malaysia’s largest pension fund for the public sector, is taking proactive steps to start the conversation surrounding ESG and climate-related risks. As one of the early adopters of the United Nations-backed Principles of Responsible Investment, the fund sees itself as a champion of investor activism and plans to use its institutional influence to engage with other environmental and investment experts on ESG.
In that regard, KWAP will be hosting the KWAP Inspire: Environmental Conference on July 17 to 18 2018. Themed “Igniting Action for a Better Tomorrow”, the conference aims to bring together environmental and investment experts to discuss issues critical to sustainable investment.
KWAP Inspire will tackle the complex and widespread debate on ESG, and by doing so, hopes to further drive consensus among the investor community that economics can in fact be complementary with the environment.
The KWAP Inspire: Environmental Conference 2018 is receiving support from key industry players such as Amundi Asset Management, BNP Paribas Asset Management, CIMB Principal Asset Management, CIMB Principal Islamic Investment, Glenmont Partners, and Kenanga Investors. For registration details and more information, please visit www.kwapinspire.com.my.