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Business Unusual

Three letters that are impacting the world of investments - ESG

12 May 2021 7:15 PM

You may not think capitalism would place an emphasis on the environment or people, but this form of it does

For profit businesses have typically optimised their operations only for profit, why put it in the name if it was not the most important factor.

But changes to the environment and a younger generation skeptical of former generations stewardship of the planet are causing a change in where they want to see their money invested.

Environment, Social and Governance investing is an evolution with investors expecting more from the companies they invest in. They are still expected to create value and grow, but the shift is for it to be sustainable and fair to the environment and the people involved in the industry.

Types of investments

Triple Bottom Line

The shift began in the mid 90s with the idea of more than one bottom line. No longer was it only profit, but now people and the planet were added to create the triple bottom line.

It remains the ideal but the challenge was how to measure it.

Socially Responsible Investing (SRI)

This is favoured by those that have strong views about what they don’t like and so avoid any industry that has an association with those values. It may be something like gambling or alcohol.

Impact investing

This is the most socially active option for investors, sometimes forgoing a return in order to promote an industry that is seeking to address a social issue. It may include non-profits

or organisations that champion specific practices. The social return is preferred over the financial one. It would be great to consider taxes as a form of impacting investing if only they were used in the way citizens hoped

Environmental, Social, and Corporate Governance (ESG)

This is similar to SRI but rather than avoiding specific industries, it actively seeks to promote those that do deliver on metrics related to ESG. Unlike impact investing though it does seek a positive return but favours long term value and sustainable growth over short term profits.

A brief history

The UN’s Millennium Development Goals sought to end extreme poverty by tackling 8 key areas that kept people in poverty. They were initiated in 2002 with a goal to achieve the goals by 2015, progress was made but the effort continues via the Sustainable Development Goals.

While governments were the ones expected to achieve the goals. UN Secretary General Kofi Anan advocated that business partner in the efforts. Following the creation of the U.N. Global Compact in 2000 to invite businesses to sign up as more socially responsible corporate citizens.

He followed this up in 2004 with a report that called for more sustainable investing based on the integration of environmental, social and corporate governance factors into capital markets. This became ESG investing.

It is a sign of how slowly some things move that something that is as old as Facebook and launched by the UN has taken till now to begin to gain traction.

The current champion for the cause is BlackRock’s Larry Fink who with his letter to CEOs this year followed up on his appeal to address climate change last year to call for companies to embrace ESG in their business or risk disinvestment.

He cites millennial investors wanting to avoid returns that give them a return that costs them a planet and for very rich investors who likewise would like to see their wealth last for generations.

The growth in capital for these investments has grown into trillions and the number of funds have ballooned.

Who is it for

  • Investors - individuals, funds and pensions

  • For companies own benefit

  • For the planet and its inhabitants

How is it determined

This is the tricky part.

Money earned is an easy measure. How you earned it is more challenging

How much was it impacting on the environment - carbon emissions, water consumption, land use, toxic emissions, packaging, electronic and material waste, energy consumption

How does it impact society - human capital, supply chains, product quality and safety, privacy and data security, ethical sourcing, transparency

Governance - pay structures and incentives, accounting, anti-competitive practices, business ethics, corruption and instability, tax compliance

Not easy to measure and can place a burden on companies to report

Getting better with indexes like MSCI and others that are creating more standard metrics and both sharing and compelling companies to begin tracking them.

They use a similar system as the ratings agencies. They range from AAA, AA and A for the top performers - BBB, BB and B for those that are doing well and CCC for the laggards.

Here are the MSCI list of best performers in South Africa.

Large auditing firms have had a shady decade, this opens the option for new smaller audit firms to not just offer an alternative but focus on creating the ways to check on the ESG aspects, this should cause the big audit firms to do the same.

Asset managers too will make their reading of corporate reports focus on ESG elements which will help with developing standards and making the business focus on a broader set of success maybe even if the short term financial returns are not as bad

Negative reaction

Berkshire Hathaway is not a fan of onerous reporting, so not a big supporter of ESG metrics. They don’t disagree with sustainability and principles of ESG so perhaps once they are easier to measure it will even more widely adopted.

Companies that are not invested in much beyond shareholder return and investors not interested in much beyond financial returns are not fans. No surprise there, but they are a smaller part of a younger generation that understands that their investments will not be worth much if the planet and society have to pay for it.

Also those chasing pure profit are likely to take chances on too good to be true investments which almost always are. You would have to be very determined to lose your money on a bad investment and then look to invest in a similar one again.

Opportunity for small business

It may offer a great opportunity for small businesses which could start a business that is already mindful of providing products that are sustainable and opt for diversity and good governance. Setting that up as an integral part of their business plan should see them able to access capital from investors looking to support them. It may be challenging but far easier for a small company to bake into their DNA than for a large corporation to change the way it works.

12 May 2021 7:15 PM

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