ESG, SRI, or Impact Investing are all terms that have become significantly more popular in the past couple of years in the financial universe than ever before. A decade ago, the average investor would not have given much thought about the environmental impact or social considerations a company has in place prior to proceeding with an investment in company “A” vs. company “B”. More weight was by far put into the bottom line – gauging the potential return to be achieved based on the financial metrics alone.

Nevertheless, an increasing number of individuals, particularly the younger generation and millennials, are growing to become much more aware of the global positive or negative impact, a company may have on the world economy. But do such considerations being made need to come at the cost of better performance? Well, not really, as in fact a number of recent studies pretty much show the contrary.

ESG investing gives importance to a company’s environmental, social and governance practices, while considering other traditional financial measures. Environmental considerations include pollution or climate change; social factors include human rights or health and safety; whereas governance practices relates to quality of management, board independence and conflicts of interest to mention a few.

Socially responsible investing (SRI) entails the removal or selection of specific investments based on certain ethical guidelines. SRI investing goes a step further than ESG by selecting a company over another based on the underlying motive, which could be religion, personal values or political beliefs. For instance, screening companies such as to avoid the gambling or tobacco industries, or selecting and giving preference to those companies which contribute to charitable causes.

Similarly, impact investing gives priority to those companies whose main objective is to accomplish goals which are beneficial to the greater good, to the society at large, and not to the company’s bottom line – such as companies specifically dedicated to find innovative clean energy, better education, improved healthcare or affordable housing.

Grouping these three categories or criteria-based investing as “sustainable investing”, one ought to understand the massive amount of inflows witnessed over the past few years. Studies by Morningstar, a data provider firm, show that in 2019 alone a record €120bn were injected into sustainable investment products. This compares to just under €50bn net inflows recorded during 2018. By the end of 2019, assets under management exceeded the €660bn mark across over 2,400 funds surveyed by Morningstar, equating to a 56% increase over the previous year – buoyed by a very positive 2019 performance across financial markets.

Climate change has been one big catalyst in driving popularity towards sustainable investing. In fact, this has substantially fuelled demand for ESG ratings. Since taking the helm at the European Central Bank, Christine Laggard had vowed to put climate change on the ECB’s agenda. Up to a few years ago, barely any central banker stated any reference to the warming climate when making their assessments of the economy. The same cannot be said today, as over 60 central bankers and regulators have now joined forces with the sole purpose of focusing on the financial consequences of global warming – the Network for Greening the Financial System (NGFS), of which both the Central Bank of Malta and the Malta Financial Services Authority are members.

Shifting back to performance, studies so far not only defy critiques that sustainable consideration to portfolio management hamper returns, but rather, data analysed by Morningstar suggests that the majority of sustainable-based investments outperformed non-ESG funds over a one, three, five and 10-year periods.

Earlier this week, Amazon announced its intension to launch a $2bn fund to invest in climate technologies. So one might question whether the next “sustainable” move made by a listed company has been made because of true underlying ethical considerations or rather just to attain a higher ESG score and avoid being left out from theme-based tracker funds or actively-managed funds. However, the truth of the matter is that sustainable or ESG factors are not just good to have but moving forward are  important to consider in order  to achieve outperformance.

When analysing performance, however, one needs to also understand the discrepancy in performance or outperformance based on the funds’ underlying asset classes. Outperformance seems to have been more robust across large-capitalised based funds, as opposed to a less rosy picture across the euro-corporate debt front strategies.

To conclude, I am not implying that one should scrap traditional form of investing, but rather, that more than ever before, such thematic investments can be used to complement one’s portfolio. The direction in which markets and the broader economy are heading clearly shows that the trend is set, where all stakeholders will surely keep sustainability and ESG considerations high on the agenda in the years to come.

 

 

Colin Vella, CFA, is Head of Wealth Management at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]