As an advocate of this approach, I believe we need to dispel a few myths that could be holding investors back from putting their money to better work.
It’s vague and woolly
There are a number of different approaches to responsible investing, and the language used to describe them can often be confusing. Values-based or ethical investing allows investors to avoid sectors or companies they feel don’t reflect their views. But values are subjective. What is acceptable to me might not be to you, or vice versa.
To go beyond good intentions, and apply rigour in our efforts to invest responsibly, investors need a framework. The dominant approach has become known as ESG, where environmental, social and governance factors are incorporated into investment decisions by fund managers.
ESG today incorporates analytical and modelling tools, to identify all of the factors affecting a company’s long-term success, beyond just what companies disclose themselves. There are even ESG ratings that can help guide investors, much as credit ratings do.
Applying an ESG framework provides more than a clear conscience. If successful, it can offer a repeatable process to manage risks and identify opportunities.
Some of the risks modern companies face, both known and unknown, were less prevalent in the past and, in some cases, didn’t even exist. It is through grasping the non-financial drivers of the business – the ESG elements – that these risks can be properly understood and mitigated.
It’s a recipe for lower returns
There can of course be no guarantees when it comes to returns from investing. The value of investments goes up and down, meaning how much your investments are worth will fluctuate over time, and you may not get back the original amount you invested.
The traditional narrative dictates that if you want to invest responsibly, however, you must expect to compromise on any financial returns you receive.
Not only have a range of studies de-bunked this assumption, but there’s a growing body of data and research – from Oxford to Harvard – that suggests investment strategies integrating ESG have outperformed over the longer term.
This should be little surprise. While we might expect a company to get away with profiting at the expense of the environment or society over the short term, in the longer run it is likely to prompt damaging regulatory and reputational costs. Investors have a major role to play in constructive engagement with companies to improve their practices and in holding boards to account where governance and broader ESG standards fall short.
The implications of poor governance, and of disregard for the environment, employees or local communities, are likely to undermine a company’s long-term performance, perhaps irreparably. For investors holding that company’s shares or debt, that could spell permanent financial losses.
It’s just a fad
The principles underlying ESG investing are not new, but there has been a surge in investor demand for investment approaches that apply these strategies.
As at February 2018, €372 billion was invested in ESG strategies across Europe, according to figures from Broadridge, up from €132 billion in 2010.
Growth in ESG investing is not only being driven by investor demand, but also the investment industry itself. The number of asset managers – M&G Investments included – that have signed up to the United Nations Principles for Responsible Investment (PRI) has risen sharply. Signatories to the PRI confirm that investors will incorporate ESG issues into their investment analysis and decision-making processes.
As investors increasingly seek ways to promote positive outcomes, and more effectively mitigate risk in the investments they make, ESG investing – weighing up all the financial and non-financial elements of a company’s investment case, and engaging with companies on these issues – is the pre-eminent framework to achieve these aims.
Ben Constable-Maxwell is Director of Corporate Finance & Stewardship at M&G Investments. The views expressed in this document should not be taken as a recommendation, advice or forecast.