Environmental, Social & Governance (ESG) investing is an umbrella term used to refer to a class of investing, which is also known as “sustainable investing.” Essentially, ESG is used for investments that provide positive returns and have a long-term impact, not just on the performance of the business, but also the society and environment.
When it comes to the technical definition of ESG, the Financial Times Lexicon describes it as “a generic term used in capital markets by investors to evaluate corporate behaviour and to determine the future financial performance of companies.”
Over the past few years, ESG investing has grown exponentially. In fact, the Global Sustainable Investment Alliance (GSIA) released its sustainable investment review of 2018, which stated that sustainable investing assets in Europe, the US, Japan, Canada, and Australia and New Zealand were USD 30.7 trillion at the beginning of 2018. This marked a 34% increase since 2016.
Hence, it goes without saying ESG investing is moving into the mainstream. But, what is the reason behind this growth? Here are the top 10 reasons why ESG investing has increased in popularity.
10 Reasons Why ESG Investing Is Growing In The UK
1. The Importance of Systematic Importance
The rise of ESG investing starting to grow after the rude wake-up call public and private sectors got during the financial crisis of 2008. This awakening showed how issues of culture and conduct have systemic importance. Hence, improving and enhancing corporate governance has become a focal point for regulators and equity investors with the assistance of active ownership.
2. The Expansion of Public-Private Partnerships
Earlier, public-private partnerships were limited to addressing infrastructure and housing needs; however, their collaboration has grown tenfold now as they tackle broader social and environmental issues. The most prominent examples of how government goals enable private capital that facilitates social investments are the U.S. municipal market and European agency market.
3. Climate Change Cannot Be Ignored
After years of denial, climate change is finally understood and universally acknowledged as a major issue. Hence, as a mitigation technique, international agreements like the COP21 Paris agreement, are focused on keeping the increase in world temperatures below two degrees. Moreover, private initiatives like sustainable investment portfolios and more disclosure climate-related financial risks are adopted.
4. The Shift of Energy Sources
Besides climate change, there is a massive shift and transformation in the energy market. With the assistance of well-telegraphed supply and demand drivers, natural gas is now cheaper than coal as renewable energy sources are cheaper and scalable.
5. Technology Has Evolutionised Our Demands
Due to advancing technology, almost every sector is facing a paradigm shift in the way business is conducted. For example, driverless cars have taken prominence in the automotive industry, while online sales are dominating the retail sector and robo-advisers in asset management. Hence, only those companies that are willing to invest in change and have multiple resources at their disposable will outperform. On the other hand, others are likely to put investors at a huge risk.
6. Convergence In Social Norms Due To Social Media
Social media is a powerful tool as it has the potential to alter the cultural blueprint of entire countries as it has a borderless nature. For investors, this means that they need to take into account the changes in individual consumer preferences and traditional election patterns, which subsequent demands for new regulations.
7. Increase In Average Life Expectancy
United Nations has reported that by 2050, there will be over 2.3 billion people in the world who are over the age of 65. Hence, with the average life expectancy increasing, especially in developed countries, sustainability issues do impact not only our future generations but also our older selves. Issues like climate change, income inequality, poor governance and healthcare are all increasingly personal as they directly affect our financial security during retirement.
8. The Change of Demographics
Baby boomers have taken the backseat now, as Millennials and Gen-Xers have taken over the position of influence and financial and political landscapes. The most prominent example of this is the newly created French government, wherein half of its members are women. Hence, these younger generations are focused on promoting the growth of the ‘green bond’ market.
9. The Impact of Regulations
With the emergence of ESG investments, new regulations have been at the forefront in multiple countries, which has highly impacted credit fundamentals. Some examples of this are the shutdown of nuclear power in Germany, France’s making the reporting of climate risk mandatory and the implementation of the Supervisory Review and Evaluation Process (SREP) in Europe. This has considerably risen the bar for financial institutions.
10. Globalization of Value Chains
The value chains of large corporations have become global; hence, they are increasingly complex. If they aren’t managed effectively, they can result in huge losses. For example, investors are extremely particular about obstructing child labour practices, human rights issues, poor governance and overall environmental impact.
Now that you have an understanding of why ESG investments are on the rise let’s discuss the best themes to invest in 2020.
The Best ESG Themes To Invest In 2020
Theme 1: The Looming Threat of Climate Change
Owing to the extreme weather events, investors are even more concerned about climate risk in each of their portfolios. Furthermore, investors are looking for fossil-fuel-free portfolios, and the demand for funding climate-change solutions through their investments is increasing too. Along with this, investor sophistication and knowledge about what their money is being used for are also increasing.
So if you are a company that does not focus much on climate change credentials, it is time to be careful. An example of a fund that is climate-change friendly is Investec Environmental Opportunities. This fund aims to identify businesses whose products can contribute actively to reduce carbon emissions. It is one of the most effective global funds of 2019.
Theme 2: United Nations’ Sustainable Development Goals (SDGs)
In 2019, we witnessed that there is an increasing demand for funds that do not just focus on solving world’s sustainability challenges, but ensuring their underlying portfolio companies are meeting specific criteria aligned to Sustainable Development Goals. One such fund with its core focus on SDGs is Montanaro Better World. It was one of the best performing funds last year. It has a pre-defined approach which involves investing across six diverse themes, each with underlying holdings mapped to the SDGs.
Theme 3: Beware of ‘Greenwash’
We all are aware that ‘bandwagonism’ is a common practice in all walks of life, and so the investment is no different. This practice refers to falsely marketing a product as sustainable. However, when you take a look at the underlying portfolio companies, this might not necessarily be the case. This is a trend you need to avoid and make sure you are invested in companies genuinely offering sustainable solutions. L&G is an ideal example with a wide range of ETFs buying baskets of companies focused on specific themes like clean water, cybersecurity and clean battery technology.
In today’s day and age, most investors aren’t only focused on the financial outcomes of their investments. Instead, they also focus on the impact of their investments and how their assets promote global issues like climate change. With the shift in the key generation from baby boomers to millennials, ESG investment is surely going to keep increasing in prominence over the next few years.
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