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ESG will drive valuations, whatever its real-world impact

Trustees support wider adoption of environmental, social and governance (ESG) investing even if it doesn’t translate into social or environmental improvement.

| 4 min read

In a study by Charles Stanley Fiduciary Management, professional trustees said they wanted greater use of ESG metrics – with 51% believing ESG should be mandated by regulation. But how effective is ESG investing – and can it really make a difference to society or the planet?

ESG has been described as an “investors’ revolution” as pressure for companies to clean up their act is coming directly from the individuals buying into their businesses. Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty.

Last year, Blackrock, the largest asset manager in the world, declared that “sustainability was its new standard for investing”. It called for chief executives to disclose more clearly how they are managing sustainability risks – and warned that companies who do not implement an adequate response will be on the losing side of a significant reallocation of capital.

Larry Fink, BlackRock’s chief executive suggested that, over time, companies and countries that ignore sustainability risks will see problems mounting in other areas. He has argued that 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.

This suggest that being lowly related on ESG metrics will not only reduce investors demand for a company’s shares or bonds – but will also impact their P&L account as the cost of debt servicing increases compared with those businesses that rate highly on ESG metrics.

ESG and the Covid-19 sell-off

Evidence that companies with higher ESG scores see their shares perform better in a crisis emerged last year in the pandemic-related sell off. 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 found that companies with strong ESG credentials experienced less negative stock returns during the market collapse. Even more strikingly, there was an even more pronounced effect in industries that were badly hit by the pandemic such as retail, restaurants, and airlines.

These issues will become more financially material over time. As the data becomes more standardised, it is likely that executives will see evidence that ESG is not just about generating a “feel-good factor” but can create real value for their business.

The global move towards better environmental standards is another theme that has been accelerated by the Covid-19 pandemic. Most of the world’s major economies are now implementing massive investment programmes in green energy, to create jobs and futureproof their infrastructure. This means the opportunities for investing in ESG businesses is likely to increase, which could be another factor weighing on the valuations of ESG losers.

Real world impact

Although intentions are clearly sound, we will have to wait and see whether ESG really can save the planet or have a significant positive impact in other areas. As with any other major change, there has been a backlash from some, who argue that the real-world reality is negligible – or that it is even harmful.

In recent months former BlackRock sustainable investing chief Taraq Fancy said ESG was a “deadly distraction” from real policy reforms, while a former executive at Deutsche Bank’s asset management arm, Desiree Fixler, called its sustainability claims “harmful posturing” in an interview with the Wall Street Journal. UK regulators are also starting to look at claims of “greenwashing” by UK companies.

However, ESG is set to become a significant driver of company valuations – even if it has impact in the real world – as investors position themselves into the ESG winners and steer clear of the losers. As more investors choose ESG benchmarks over traditional indices, the difference between being an ESG “winner” and “loser” is likely to become much more meaningful.

Source: Charles Stanley / Censuswide. Research was carried by Censuswide among 55 professional trustees of UK DB pension funds. The survey was completed between 21/07/2021 – 04/08/2021.

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ESG will drive valuations, whatever its real-world impact

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