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Invest in firms with good environmental and social practices for better returns

One of the buzzwords in investing these dates is ESG, which stands for environmental, social and governance. A key question is whether it makes a difference to your investments.

Invest in firms with good environmental and social practices for better returns
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One of the buzzwords in investing these dates is ESG, which stands for environmental, social and governance.

A key question is whether it makes a difference to your investments.

Research shows that companies with good ESG practices do well for the community and their investors.

WHY IS IT IMPORTANT?

While ESG concerns date back decades to issues such as apartheid in South Africa in the 1980s and environmental concerns in the 2000s or earlier, the focus has intensified in recent years as more people prefer to buy from companies with environmental and social practices that match their own values. An ESG assessment can indicate whether a company does help to protect the environment and support communities.  

The range of issues that ESG covers are quite broad.

Beyond climate risk, for example, environmental concerns include natural resource scarcity, pollution and waste.

Social issues include labour practices, product liability and how a company interacts with the community.

And governance includes behaviours such as corporate reporting and decisions by the organisation’s board.

The reason companies are now more interested in ESG goes beyond just building a better environment and society.

Investment advisory firm Morningstar explains that beyond being good for the planet, environmental stewardship is also about controlling costs, avoiding damaging incidents and positioning for tomorrow's economy.

Similarly, treating workers well benefits society and helps a company attract and retain talent.

Good governance leads to better corporate decision-making, better strategy and more focus on creating an enduring franchise.

Investment management firm Pimco notes that evidence shows companies that manage sustainability issues effectively gain competitive benefits including resource and cost efficiencies, productivity gains, new revenue opportunities, and reputation benefits. 

Here in Singapore, the Singapore Exchange (SGX) established a rule requiring listed companies to describe their sustainability practices in their annual report. The reason, SGX explained, is that adding sustainability reporting to financial reporting provides a more comprehensive picture of the risks and opportunities for future returns.

These issues are important for investors as well.

Ms Eugenia Koh, head of impact investing and engagement strategy at Standard Chartered Private Bank, said that millennials, in particular, are investing with their values and are twice as likely to invest in companies with positive ESG outcomes.

WHAT DO INVESTMENT RESULTS SHOW?

There have literally been hundreds of studies on the results of ESG investing, and the vast majority show positive investment results.

Bank of America Merrill Lynch found, for example, that “you can do good and do well”.

Its analysis of S&P 500 stocks found that stocks with high environmental rankings outperformed their low-ranked counterparts by 3 percentage points or more a year between 2005 and 2017.  

The United States-based Chartered Financial Analyst (CFA) Institute similarly said that stocks with high ESG scores have higher valuations and lower volatility than their less-conscientious counterparts.

A study led by Harvard Business School professor George Serafeim found that companies that developed organisational processes to measure, manage and communicate performance on ESG issues in the early 1990s outperformed a carefully matched control group over the next 18 years.

As one example, DWS, the asset management arm of Deutsche Bank, launched an ESG version of its MSCI World UCITS exchange-traded fund (ETF) in May 2018.

The ESG version outperformed across three-month and one-year timeframes, with a one-year return of 2.3 per cent for the ESG version and 0.4 per cent for the original ETF.

When stock market index provider MSCI applied an ESG filter to a highly selective universe of 100 companies that were already been screened for value creation, it found that companies with higher ESG ratings had higher average returns than companies with lower ESG ratings.   

HOW TO SELECT INVESTMENTS?

The question for investors, then, is how to select stocks of companies that have better ESG performance.

One way is to analyse individual companies’ ESG practices. Once you select a stock you want to invest in, you can review the ESG report that was filed with the SGX to determine whether its EGS practices match your own values.    

A less time-intensive method is to use an exclusion policy, so that you avoid companies in certain sectors such as coal production, weapons or palm oil production. 

Investors can also put their money in unit trusts or ETFs.

While ESG-focused ETFs have yet to reach Singapore, the Blackrock Singapore prospectus for global funds shows options such as the ESG Multi-Asset Fund and the ESG Emerging Market Bond Fund.

There are also more than 80 ESG-focused ETFs in the US, so investors could select one using sources such as the ETF.com website and invest through a brokerage firm in Singapore that allows access to US markets. 

Investors should look at ESG reports carefully, though, since companies that have ESG practices or appear on ESG rankings may still not fully follow sound practices.

CSR Europe, a business network for corporate social responsibility, found that while 72 per cent of companies in Europe had embedded sustainability at a strategic level, for example, only 35 per cent had actually implemented impact projects.

And Australian online newspaper The Fifth Estate noted that the Morningstar Sustainability Atlas 2019 gave oil and gas producer Galp Energia a top score in its ESG ratings for being less bad than others.

While it is still important to select companies or funds based on sound financial fundamentals, adding ESG as another factor and analysing company practices carefully can give investors better returns and help the planet at the same time.

Related topics

ESG environment social governance investment stocks

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