Over the last few years, asset owners and managers have committed to investing more in renewable energy infrastructure and reducing their carbon footprint as part of an effort to focus on the “E” branch of the ESG (Environmental, Social, and Governance) tree.
However, even though the financial media covers the environment extensively, institutional investors and other stakeholders are more and more aware that they must consider all three branches of ESG to be truly responsible investors, said Doug Bell a senior investment strategist for the Guardians of New Zealand Superannuation (NZ Super).
With the focus on the transition to a low carbon economy, it is also pivotal to consider the social impacts of the transition such as the impact on workers, communities and society at large to achieve a ‘just transition’, Bell told AsianInvestor.
“You hear a lot of discussions about the ‘just transition’, which relates to transitioning the global economy to a more sustainable footing, but to do so in a way that is 'just' on a societal basis," he said.
"It's a big trend taking place with a lot of momentum behind it means companies should absolutely be focusing on all three aspects of ESG."
RUNNING THE RISK
NZ Super manages around $40 billion in assets for the New Zealand government, so views the integration of social and governance principles into their investment decisions as significant in mitigating risk for the future.
“Social and governance issues are particularly material for company share prices and you’ll find that scandals have arisen more often from these elements, as opposed to climate or environmental elements,” said Bell.
“If a company is taking these considerations into account, and are proactive in their thinking about them, we would expect that they're probably going to do better over time, on the basis of that they will be more responsive to the challenges and uncertainty they face in the future.”
Dr. Xinting Jia, ESG investment strategist in Asia Pacific for State Street Global Advisors agrees that companies who fail to address social and governance aspects — such as human capital, data privacy, and Diversity, Equity, and Inclusion (DEI) issues — may expose themselves to significant risks
“Like climate risks, social risks can also be material financial risks and failing to address these issues can affect long-term risk adjusted returns for investment portfolios,” Jia told AsianInvestor.
“Specifically related to diversity, a growing body of research suggests that diversity can drive returns, and that boards that neglect this topic face risks to their reputation, productivity and overall performance.”
“More broadly related to the social aspect such as gender, ethnic and cultural diversity, research shows that companies with high gender diversity are 21% more likely to outperform on profitability than others, and companies with high ethnic and cultural diversity are 33% more likely to financially outperform,” she said.
Research shows that companies with greater levels of gender diversity have stronger financial performance as well as fewer governance-related issues such as bribery, corruption, shareholder battles and fraud, according to Jia.
MEASURING THE IMPACT
The ability to measure and quantify impact is an issue for all elements of ESG investment – the “E” pillar as well as “S” and “G”.
Taxonomies and the approach to ESG ratings vary across the world and within regions, as investors seek to assess specific investments in the context of general aims. Inconsistencies within these approaches cause assessment mismatches.
There’s too much ink spilt around quantification of ESG issues, which is often something of a red herring, and which can lead to an over-reliance on quantification for insight, according to David Smith, senior investment director of Asian Equities at abrdn
“Even for those ESG issues with a more naturally quantitative angle including carbon emissions and carbon intensity the numbers alone don’t tell the whole story,” Smith told AsianInvestor.
“As active managers we look to understand the metrics where metrics are appropriate, but also to layer on top of that our own qualitative assessment around strategy, process, governance and so on. A simple, standalone carbon emissions statistic is not very useful unless it is considered in the context of a broader carbon reduction strategy, for example,” he said.
Despite the challenges, there are metrics to measure S and G, according to State Street’s Jia.
“For example, employee diversity can be measured by gender, race, and ethnicity — applicable to markets that are legal to collect and disclose this information — of the workforce,” said Jia.
“Corporate governance can be measured by board composition including gender, racial, and ethnic makeup of the board of directors in aggregate or at an individual level which can help investor understand the diversity of the board,” she said.