Patience may be required before investors can profit financially from ESG investments, but standards and ratings that are hard to compare with each other are not helping those that want to undertake this type of investing, say senior investment executives.
The former chief of one of Malaysia’s most important pension funds warned against measuring financial returns on environmental, social and governance investments using the same timeframe as “traditional” investments, as this might mislead investors into thinking ESG projects are less lucrative.
“With traditional financial investments you would normally expect returns within three to five years, but it's been shown that sustainability projects require a gestation period of anywhere from seven to nine years,” said Employees Provident Fund (EPF) former chief executive officer Alizakri Alias, speaking at AsianInvestor’s Asian Investment Summit on Wednesday (June 2).
He compared ESG investing, still in its infancy, to the early days of tech investment.
At the same time, Alias and other speakers at the event said investors could do with better standards and ratings for ESG investments.
“ESG for one company is radically different than from another,” he said, adding that asset owners like EPF struggle to identify what targets to set when it comes to carbon emissions. “When adhering to the GHG Protocol, for example, do you go for Scope 1, 2 or 3?”
Alias believes unattainable targets discourage some investee companies from pursuing change. "This is where regulators need to step up and engage with industry on setting realistic targets rather than employing a patriarchal, top-down approach. You don’t want to kill the goose that lays the golden egg.”
Karin Ri, director of responsible investment at Japanese investment firm Asset Management One, agreed: “We see there are so many ESG investing-related terminologies and they seem to be used by different people for different meanings.”
Both highlighted that while credit ratings are generally consistent, ESG scores and rankings can diverge depending on the provider and rating system used. A recent MIT-Sloan paper showed the correlation between ESG ratings across different providers is around 0.3, whereas the correlation between credit ratings by S&P and Moody’s is around 0.99.
“[A lack of consistent ESG ratings] was one of the big challenges for us when we wanted to invest in different sectors or geographies," said Alias. "One [rating] company may be very strong in the US, for example, but you're not able to apply that same rating system for the Asian market.”
MEASURING INVESTMENT RETURNS
Another investor told the same event that his organisation wouldn’t necessarily have to maximise returns on an ESG investment if it delivered measurable social returns or enabled it to manage risk.
“As long as that investment provided some decent return in line with what we are seeking, if we can achieve a positive impact, then it's good to have invested internally,” Dong Hun Jang, chief investment officer of South Korea’s Public Officials Benefit Association (Poba), said.
He also stressed the importance of meeting targets for returns. “We are not a charity. We definitely seek some decent level [of return],” he said.
Alias and Ri agreed that social, rather than financial, returns can often be more immediately obvious. “We're not just doing ESG for the sake of it – we need to make sure it's for the long-term financial returns. But in the meantime, it’s good for the sustainable growth and development of society,” said Ri.
E IS KING?
All panellists believe ESG will become ubiquitous across portfolios in the coming decade.
Alias said he worries the ‘E’, or environmental aspect, of ESG is taking too much precedence over the ‘S’ (social) and the ‘G’ (governance) in the minds of investors due to “media splashes” and “climate celebrities”.
“E becoming big because of PR,” he said.
A headline-grabbing report by the UN Intergovernmental Panel on Climate Change claiming the world has 12 years to limit a climate change catastrophe; the Swedish activist Greta Thunberg; and the emergence of prominent global protests such Extinction Rebellion UK are all examples of this, he added.
“You also have young people taking litigation against companies like Royal Dutch Shell or against countries like Germany, UK and France. Meanwhile, the social aspect is not sexy, and governance is expected.”
Ri, however, said she believes investors are making a mistake if they consider the three aspects in isolation, saying they are complex and interdependent.
“Climate change is not only an environmental, but also an unprecedented economic and social challenge. You cannot tackle the E separately from the S or G issues.”