What are ESG investments and why they are important

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

Everyone seems to think about ecology and social equality. And this brings benefits to private investors, and not only financial ones.

What is ESG investment

ESG investments are long-term investments in companies that protect the planet, improve the quality of life for people and are well managed.

To find such companies and invest in them it was easier, financiers and environmentalists have developed three factors, which are abbreviated as ESG: ecology, social responsibility, corporate governance. Different indicators are sewn inside each:

• Environmental. The company should not harm the planet: badly influence the climate, produce greenhouse gases, dump waste, destroy forests, deplete natural resources and use non-renewable energy sources such as gasoline or diesel fuel.
• Social. The company must provide good working conditions, protect the health of employees, monitor occupational safety and gender equality, and establish relationships with suppliers and consumers.
• Governance. The company must maintain a reasonable salary and management structure, conduct audits, develop a tax strategy, respect shareholder rights, and deal with internal security.

There are a lot of indicators, the specific set depends on the sector of the economy in which the business operates. For example, it is important for oil companies to consider environmental factors, while for banks it is important to consider corporate governance and customer relations.

Investors also prefer different ones for themselves Social Investment: Review of Foreign Strategic Practices A Beginner's Guide to Responsible Investing in ESG-Investing Infrastructure:

• Thematic investments. Some people choose green companies for investments. For example, some finance the construction of solar panels, while others finance wastewater treatment. It pays off: the cost of such European firms in 2007-2015 increased by 448% in Eurosif European SRI Study 2016.
• Positive selection. Investors support companies that are the best in adhering to ESG principles in their industry. For example, solar energy producer Sonnedix built an Infrastructure responsible investment strategies power plant to anti-storm standards such that hurricanes damage no more than 0.5% of solar panels. Accordingly, the company loses less money in natural disasters than other manufacturers.
• Negative selection. Investors refuse to invest in specific companies or sectors that do not support ESG principles: in the producers of alcohol, tobacco, weapons or petroleum products. For example, although the Dakota Access Pipeline was built, its operator company was mired in lawsuits from tribes that were deprived of clean water. Investors in this firm lost some of their money, and an ESG investor would not even have invested in it.
• Direct participation. Some investors are beginning to actively influence the companies in which they have invested: they demand to pass resolutions and vote on environmental and social issues, even change management for better management.

Why you should consider ESG criteria in investing

Because you can't ignore what Sustainable Signals is interested in: Individual Investor Interest Driven by Impact, Conviction and Choice. P. 4, gr. 1 half of the total US population and 70% of this country's millennials.

	How many people in the US are interested in ESG investing?	How many millennials in the US are interested in ESG investing?
2015 year	19%	28%
2017 year	23%	38%
2019 year	49%	70%

There are several more arguments in favor of the fact that it is no longer possible to ignore ESG in financial strategies.

ESG companies rise in price because they are supported by large investors

Institutional investors - insurance companies, funds and banks - are promoting Sustainable investing: fast-forwarding its evolution ESG-agenda is the most active: 91% of them are developing ESG-investing strategies. Such organizations take money from thousands of private investors, and therefore manage tens of billions of dollars. Thanks to institutional investors, the amount of capital in responsible investments has overstepped the ESG factors in investing. S. 630 trillion dollars.

Some investors set up ESG organizations like PRI, GSIA, GIIN or IIGCC. The most active association is Climate Action 100+: it consists of more than 500 investors who manage $ 55 trillion. They can push the stock of a firm up by the very act of investing.

The energy company NextEra, with their support, has grown by 443% in 10 years. This is because in 2011 it announced that it would start generating electricity mainly from renewable sources: wind and sun.

Another example is Aedifica, which invests in medical real estate for seniors in need of care. It suffered a little during the 2008 crisis, but since then large investment funds have invested in the company and it has grown by 204%:

But the shares of oil companies BP and ExxonMobil over the same 10 years fell by 41% and 29%, respectively.

ESG companies receive aid and benefits from governments

States are developing PRI Consultations and letters 2021 laws and guidelines that force companies to disclose ESG metrics. Accordingly, it is easier for investors to make decisions:

• The European Union has adopted a classification of climate activities, a directive on sustainable development reporting rules and a requirement to take ESG factors into account in financial advice.
• The UK is preparing disclosure requirements for climate-related financial information and guidelines for the publication of non-financial ESG information.
• The US is discussing guidelines to disclose information on environmental impact, gender equality, and the cost of political lobbying. Requirements are also being prepared to take ESG factors into account when assessing the risk and profitability of deposits.
• China encourages investors to take ESG factors into account and obliges companies to publish them in their reports.
• Russia is creating the Concept for the Organization in Russia of a Methodological System for the Development of Green Financial Instruments and Responsible Investment Projects, a Climate Change Adaptation Plan for Government Agencies, the Doctrine of Environmental and Energy Security and the Ecology National Project, which requires the reduction of harmful emissions from enterprises.

Governments also help ESG companies themselves - they exempt or reduce taxes. They also invest in research and development or subsidize products.

For example, the Chinese government is trying Electric mobility after the crisis: Why an auto slowdown won’t hurt EV demand to make electric vehicles from local manufacturers more affordable. Buyers are exempt from purchase tax and add up to 22,500 yuan (258,000 rubles). If an electric car, such as the Pocco Meimei, costs 29,800 yuan, then in fact you have to pay 7,300 yuan. It is also profitable for manufacturers, because sales are rising, and it is easier to compete with foreign models.

Benefits for investments in ESG projects are given by the Government Decree of April 30, 2019 No. 541 "On approval of the Rules for the provision of subsidies from the federal budget to Russian organizations to reimburse the costs of paying coupon income on bonds issued as part of the implementation of investment projects to introduce the best available technologies" and in Russia. For example, for green bonds - securities, with the help of which they raise money for projects that help to improve the environment or minimize harm to nature. If the company places such bonds, then it will not have to pay interest out of its own pocket: the state will reimburse the coupon income to investors. And the investors themselves can make money on the price of bonds:

Investors may refuse to work with green companies

Large investment funds are already forcing companies to behave ethically:

• New York State's three largest retirement funds are divesting Mayor de Blasio, Comptroller Stringer, and Trustees Announce Estimated $ 4 Billion Divestment from Fossil Fuels from $ 4 billion in oil and gas investments, gradually selling shares in these firms and donating money to greener firms.
• Investment bank Goldman Sachs has refused the Environmental Policy Framework to invest in the development of oil and gas fields in the Arctic.
• A group of investors in the pharmaceutical company Purdue Farma has bankrupted With $ 2, 300 Phone Calls, Purdue Runs Up Huge Bankruptcy Tab, it has filed $ 400 million in claims over an opioid drug scandal.
• Investors threatened to sell their shares and change directors if the oil company Exxon Mobil did not cut emissions. The corporation has promised Exxon Mobil, under pressure on climate, aims to cut emissions intensity by 2025 to halve them. After the announcement, its shares climbed 46% in five months:

Investors love caring for the world

This is a simple argument: it's nice to make money on what is good for the planet and humanity.

As noted in the article Nobility Exchange: Who Needs RBC's highly moral investments and why, over the past century, people have begun to live better and have coped with global problems.

Dmitry Alexandrov Investment Director of the Investment Company "Univer Capital".

This allows millennials to pay attention to fundamental values related to quality of life, even when making investment decisions.

How to rate companies by ESG

Investors study a variety of sources and then put it all together. This is where the pros look for the Sustainable Investment Survey 2020. P. 20 for information on potential ESG investments:

Webinars and / or conferences	64%
Marketing presentations and / or case studies	54%
Organizations that research sustainable development	53%
Media: TV, newspapers or podcasts	42%
Own research	40%
Investment organizations	23%
Invited consultants	20%
Regulators	11%
"We are not looking for"	6%
Other	2%

The average investor can evaluate What a Difference an ESG Ratings Provider Makes an ESG company in three ways:

• Fundamental. Collect hundreds of ESG metrics that are published by firms themselves or by data providers like Bloomberg or Refinitiv. Then develop your own methodology by which to buy assets.
• Specialized. Examine company assessments for specific ESG factors: carbon metrics (greenhouse gas emissions, electricity consumption and offsetting), corporate governance, or human rights. Such data are published, for example, by TruCost, Equileap or the Carbon Disclosure Project. The method is suitable for investors who do not want to support ethics in general with their money, but to solve a narrow problem.
• Comprehensive. Use ESG ratings provided by financial companies. It combines objective and subjective data: public metrics and assessments by experts and analysts.

Almost all major investment and analytical companies make up ESG ratings: MSCI, TruValue, Vigeo Eiris and Sustainanalytics. Not every business in the world gets there, but you can find famous or large ones.

For example, electric vehicle manufacturer Tesla has above average scores. The company is distinguished by corporate governance and sustainable production capabilities: the potential for the development of green technologies and the percentage of income that the company receives from them. At the same time, Tesla is failing product safety and personnel management, according to MSCI ESG Ratings Corporate Search Tool.

Resource firms have low indicators. Thus, Gazprom was recognized as the middle peasant in terms of ESG factors among oil and gas companies, and among all corporations it was in the last quarter of the rating. But, the authors of the list admit Sustainanalytics Company ESG Risk Ratings, management works well with ESG:

It is better to look for small companies in local analytical sources. For example, the energy company Enel Russia is assessed by the RAEX agency, which has compiled ESG ratings of Russian companies ESG rating of Russian companies and regions ESG rating of Russian regions:

What is the difficulty with evaluating companies according to ESG

Investors have not yet agreed on what to count ESG and how to evaluate it. And the states have not decided who and for what to give benefits.

There is no universally accepted definition of ESG

The definition of ESG investing at the beginning of this article is just one version. In addition to it, there are several other ways to describe ESG, and everything is about the same factors: ethics, sustainability and social responsibility.

The problem is that ESG criteria, even if they are clear and measurable, can be applied to almost any company. Let's say the social network Facebook has a low MSCI ESG Ratings, Facebook, $ FB ESG rating: although there is no negative impact on nature, corporate strategy and poor data privacy pull the social network down.

Therefore, the share of different sectors in ESG funds is practically the same as in the regular stock market. For example, the preponderance of technology companies and a small share of energy - although it was green energy that pushed the development of ESG:

ESG assessment methodologies vary widely

There are more than 600 ways of ESG data in the world: Dazed and confused to evaluate a company by ESG, and each will show its own result. Investors are debating that it is time to create a common system like accounting standards. Some financial companies are already writing CFA forges ahead with ESG standard despite criticism drafts of such a system, but it is still far from large-scale implementation.

Another consequence is that rating companies have different ESG criteria: some take into account emissions from production in the moment, others - in dynamics; highly qualified employees are important for one, the absence of discrimination at work is important for the second.

As a result, it turns out that the estimates of the same company are different. Electricity producer NextEra is considered the industry leader by MSCI MSCI ESG Ratings:

But this same company is a strong middle peasant from another agency, Refinitiv Refinitiv ESG company scores:

Economists at MIT are also seeing Aggregate Confusion: The Divergence of ESG Ratings scatter. They note that this is a major barrier to making informed investments in responsible firms. There is even a list of 25 companies with the largest scatter of ratings from major rating agencies:

The profitability of ESG companies is calculated in different ways

The benefits of investing in ESG companies also depend on who, how and why counts. It turns out that responsible investments are both profitable and unprofitable.

For example, Fidelity's ESG index fund grew 33% in 2020. By comparison, the regular S&P Global 1200 Index climbed 23% over the same time period:

ESG companies are also better than Outrunning a crisis: Sustainability and market outperformance. S. 3 showed itself during the big fall of the markets in early 2020. Rating agencies give companies "ESG-points", where A - the highest category, E - the lowest. Here's how many firms of different categories lost between February 19 and March 26 (compared to the US market S&P 500 index):

ESG rating	Profitability
A	−23, 1%
B	−25, 7%
S&P 500	−26, 9%
C	−27, 7%
D	−30, 7%
E	−34, 3%

Other studies, on the contrary, show lower profitability of ESG companies in comparison with the market. Thus, the financial and analytical group Factor Research evaluated ESG data: Dazed and confused 790 American firms with ESG ratings. It turned out that ESG companies are less volatile (the price deviates less from the average) than traditional ones, but they are also less profitable:

The third group of studies confirms that the returns on ESG indices differ little from the U. S. Savings Rate Spikes from common stock indices. Both are indicators that track the value of a certain group of securities. The Daily Shot service compared them with each other: the difference was not big.

Return of the ESG-index for 5 years	Return of the regular index over 5 years
FTSE 4GOOD All-World Index: 97, 8%	FTSE All-World Index: 95, 8%
MSCI World ESG Universal Index: 57, 4%	MSCI World Index: 55, 4%
Dow Jones Sustainability World Index: 78, 9%	Dow Jones Composite Average: 84, 2%

How to invest in ESG companies

ESG investing is a difficult task, you need to consider the pros and cons. But if you care about the planet and the people who live on it, here's how to invest in ESG companies.

Buy a stake in an ESG fund

The easiest way is to buy a share in a fund that has already selected assets according to ESG criteria. The choice depends on which stock markets are available to the investor:

• US exchanges. They trade 140 Socially Responsible ETFs 140 Socially Responsible ETFs with different returns, different asset sets and sizes. The largest is the iShares ESG Aware MSCI USA ETF, with $ 15 billion in assets. Over the year, it has grown by 47%.
• St. Petersburg Stock Exchange. Through it, you can buy about 80 foreign funds, including ESG. The condition is to be a qualified investor, which not everyone can afford. This is a special status that requires assets worth six million rubles or a special financial certificate.
• Moscow Exchange. Two funds from Russian companies are available to ordinary investors: SBRI (450 million rubles under management) and ESGR (148 million rubles under management).

It is useful to see exactly what shares the fund bought: it so happens that this is a set of pharmaceutical or technology companies that only formally meet the ESG criteria.

Buy ESG shares or bonds yourself

Russian investors can buy shares of most companies through their broker. Before purchasing, it is worth studying:

• Ratings. It is better to look through a few and calculate for yourself the average rating of the company that interests you. The largest free rankings providers are MSCI, Sustainanalytics, Refinitiv, and RAEX.
• Indices. They show how ESG companies developed in dynamics: S & P Global, Bloomberg, FTSE Russell. The main indices for Russian companies are “Responsibility and Openness” and “Vector of Sustainable Development” from the Russian Union of Industrialists and Entrepreneurs.

Green bonds are essentially the same as regular bonds. The difference is that investments are spent on financing environmental projects: reducing greenhouse gas emissions, purchasing electric vehicles or recycling waste. Here's where to get them:

• There is a sector on the Moscow Exchange where one and a half dozen green and social bonds are traded.
• On foreign exchanges, there is a choice of individual company or fund bonds, such as the Xtrackers J. P. Morgan ESG USD High Yield Corporate Bond ETF.

Give capital to trust

Trust management is an agreement under which an investor transfers capital to a bank or financial company, they invest it, and the profit is divided.

This strategy is suitable for investors who are ready to invest several hundred thousand rubles - they do not accept less. It is better to check the specific conditions and characteristics of investments with banks and management companies - everything is very different.

What to remember

1. ESG investing is when you invest in the securities of companies that are trying to preserve nature or help society.
2. ESG stands for enivornmental, social, governance, which translates as “ecology, social development and corporate governance”. These are groups of special criteria that are used to evaluate a business. Each indicator contains dozens of metrics. For example, “ecology” includes climate change, greenhouse gas emissions and industrial waste.
3. Responsible investments are supported by 90% of large investors. They invested $ 17 trillion in ESG companies worldwide for 2020.
4. Investors evaluate companies by ESG in different ways - they study special ratings, indices and analyst reports.
5. Responsible investment is still evolving, so no one is sure how to properly award and weigh ESG factors. Uniform standards for investors and companies are just being developed.
6. The easiest way to invest in an ESG business is to buy a share in an exchange-traded fund or a share of a particular company.