Sustainable investing that categorizes binary outcomes as ‘good’ or ‘bad’ creates dangerous precedents. Not only does it undermine an institutionalized structure that encompasses market research, financial analysis, and independent due diligence, it distracts from the social objective it hopes to achieve.
At a time when companies are looking to improve their environmental, social and governance (ESG) footprint while capital providers are pursuing purpose-driven opportunities, active fund managers sit at the forefront of change. More difficult is bringing forward perhaps a less obvious truth: ESG investing is probably just a better approach to investing.
“Incorporating ESG engagement and analysis into the decision-making process is simply a good investment practice,” comments David Wong, equity strategist at AllianceBerstein. “Viewing capital allocation through an ESG lens enhances risk-adjusted returns and supports more accurate price discovery.”
This involves fund managers asking a revised set of questions with company executives. ESG-focused enquiries like “how are different businesses units prepared for rising sea levels?” or “what actions are being taken to incorporate a potential carbon tax?” now compliment traditional analysis, like asking about a company’s pricing strategy or debt-level covenants.
The new normal
If navigating through the market landscape were not challenging enough, money managers are already grappling with low interest rates, geopolitical tensions, and an uneven economic recovery. Amid the plethora of issues, the temptation to dilute an ESG-approach exists.
“But a binary framework fuels capital misallocation, while also overlooking individual company achievements to improve their social footprint, be it incorporating energy efficiency technology or expanding diversity on its management board,” explains Wong.
Since asset managers are judged by their fund’s ability to generate alpha – the excess return of an investment relative to a benchmark – engagement focused around sustainability reinforces client interest to drive long-term value creation, rather than thwart it.
The view is echoed throughout the industry. Deeper analysis incorporating investments within an ESG-lens more accurately evaluates the sustainability issues that impact future cash flows that underline a company’s value. Over time, not embedding these variables weaken the financial analysis that upholds asset manager’s fiduciary responsibilities.
Engagement becomes part of the new normal, but serious work is still ahead. Frequent occurrences of extreme weather alongside cases of corporate fraud or executive mismanagement, highlights the importance to consider using an ESG lens sooner.
The need to act now
What happens over the next decade meaningfully impacts both the investment landscape and the planet later this century. The United Nation Sustainable Development Goals (UN SDG) has identified 17 areas to transform the world to address some of these challenges, with a preliminary cost estimate of $90 trillion over the next fifteen years.
To meet these demands, a collaborative approach is required, with the daunting task of identifying, maintaining, and strengthening overlapping goals among company executives, investors, and local communities to improve returns without burdening excess social costs later in the future.
For companies, ESG engagement provides operational insight into its financial performance that supports immediate and longer-term success. Green bonds support environment-related projects while value-focused investors that appreciate a company’s efforts to mitigate ESG risks can help lower a company’s cost of capital.
Because the impact of climate warming is unlikely to reverse, ESG engagement trends are unlikely to renege either. Since investors are leading the process, regulators are establishing ESG standards and frameworks to ensure that best practices become more commonly accepted.
Calls for greater transparency, increased annual general meeting (AGM) participation and corporate governance information builds on the idea that capital can be mobilized beyond the singular pursuit of generating financial returns will only become louder.
In an early August report, the United Nations Intergovernmental Panel on Climate Change (UN IPCC) highlighted the urgency to address rising temperatures, emphasizing the need for investors need to work with companies and shareholders to incorporate ESG issues now. Otherwise, there will be no good outcome for anyone, just a bad result later.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.
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