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ESG investing: What’s most important – the E, the S, or the G?

An economically efficient and sustainable global financial system is a necessity for long-term value creation. ESG will help this be achieved.

Planet earth with the word ESG on top

Bob Campion

in Fiduciary news


As long-term asset owners, trustees are under pressure to ensure their managers are taking proper consideration of environmental, social and governance (ESG) issues when making investment decisions. But in a complex multi-asset portfolio, how are these factors integrated into investment analysis – and which is more material, the ‘E’, the ‘S’ or the ‘G’?

Last year, index provider MSCI undertook an in-depth study of the impact of ESG factors on the performance of companies in different sectors. The main thrust of the research was to determine whether the governance factor (the G in ESG) was the most important driver of performance for companies – and whether the weighting of E, S and G factors makes any difference to long-term performance.

MSCI’s concluded that, while the G in ESG had more impact on companies’ share-price performance over a short period (one year), over longer time periods all three factors were deemed critical to outperformance. The researchers used live MSCI ESG Ratings history over the previous 13 years.

The study also discovered that the weighting of the E, S and G factors within each industry can have a big impact on the performance of an ESG index over long time periods.

The pressure on companies to release detailed information from investors is real. In the US, the Securities and Exchange Commission (SEC) is planning to make ESG disclosures mandatory – and is currently consulting on exactly how this should be done. Major investors such as Pimco, Invesco and other large asset managers want ESG information to be included in the 10k annual report filing. They want as much disclosure as possible because that’s what clients are telling them they want.

However, some parts of corporate America are resisting this move. US tech giants are urging the regulators not to move so fast.

In submissions to the SEC, both Microsoft and Google have argued that ESG information should not be included in 10k’s as this would open them up to potential legal risks, since such data is subject to more uncertainty than the detailed financials and risk disclosures that are currently required in this document.

Overtime, companies that fail in ESG factors could also suffer margin erosion as their borrowing costs rise, according to the head of the world’s-biggest investor. Larry Fink, BlackRock’s chief executive, has suggested that companies and countries that ignore any sustainability risks will see problems mounting in other areas. He thinks this will lead these businesses to encounter growing scepticism from the markets, and in turn, higher borrowing costs when they approach a bank for financing.

Following last year’s Covid-19 sell off, evidence is emerging that companies demonstrating strength in ESG factors performed better during the crisis. George Serafeim, a professor at Harvard Business School, analysed the share-price fall of more than 3,000 companies all over the world as Covid-19 spread. He concluded that companies with strong ESG credentials experienced less negative stock returns during the market collapse. Many studies had similar conclusions, although some question their methodology.

So, how do we, as stewards of wealth, take these ESG factors into consideration when making investment decisions?

The big issue for investors is that there are currently no global standards, but this issue is being rectified. In March, the IFRS Foundation said it was continuing to work towards setting up an international sustainability reporting standards board. A final determination about any new board will be made ahead of the November 2021 United Nations COP26 conference in Glasgow, where countries will make firm commitments to slash their output of emissions.

Already, 120 countries use the IFRS Standards as the foundation for company financial disclosure, making it more than likely that these countries will endorse and require companies to use the new ESG standards.

Charles Stanley has partnered with MSCI to embed ESG metrics into our risk and portfolio management framework. MSCI provides us with industry leading ESG data and research. Boasting more than 40 years of experience, measuring and modelling ESG performance, MSCI rates over 680,000 equity and fixed-income securities worldwide and was voted best firm for Socially Responsible Investment (SRI) and governance research for the past four years.

The ‘E’ the ‘S’ and the ‘G’ should all be considered when making an investment decision. Of course, there will be sectors such as mining where the “E” factor is prominent, but with investment managers having ESG scores and breakdowns at their fingertips, they are able to make informed judgement calls.

Clearly, an economically efficient, sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society. The three issues represented under the umbrella of ESG investing can help make this a reality.

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