With environmental conditions deteriorating, concern about climate change, human rights, and corporate abuse ever-increasing, sustainable investing has been gaining immense popularity, especially among millennials.
Capitalism is driven by the motive to make profits. However, there must be a way to make profits as well as be responsible. In the late 1700s, in Colonial America, Methodists, and Quakers, who were subsets of Protestantism, let their investments be guided by religious and moral beliefs. They were of opinion that industries involving alcohol, tobacco, violence, and slavery were immoral and in turn, refrained from investing their money in such ventures, beginning the idea of impact investing.
SRIs (Socially Responsible Investments) have since been associated with moral values. In the 21st Century, the concept of “ESG” has brought a fundamental change. Coined in 2005, in a UN commissioned a report titled “Who Cares Wins”, ESG stands for Environmental, Social, and Governance.
Now instead of thinking of a company as completely bad or completely good, one can make a comparison based on ESG criteria which are believed to help a more rational analysis.
Major rating agencies today assign ESG scores to ETFs, Mutual Funds, and individual companies. Currently, there is no uniform rating standard. However, looking at scores by several agencies and how they have been calculated can provide a better understanding.
The E or Environmental aspect looks at factors including use of natural resources, pollution level, and sustainability measures. Companies using more renewable resources with a reduced carbon footprint are likely to have a higher E score. The S or Social side takes account of corporate behaviors that impact the public. For example, when Walmart stopped selling certain ammunition in 2019, responding to the increasing gun violence, it was found that people preferred shopping there more which in turn enhanced their S points. The G or Governance facet measures the ethics and transparency of the leaders of companies.
What impact can this approach have? Let us take an example of protest divestment. American University students and teachers in the 1960s and 1970s protested against the Apartheid in South Africa. Teachers and students pressurised schools to completely stop investing their endowments there. It was a radical move considering around one-third to half of the S&P 500 did business in South Africa. In 1986, Congress banned any new US investment in South Africa which resulted in a billion-dollar loss of capital for South Africa. Decades of political resistance along with the economic fallout led to the end of Apartheid in the early 1990s.
In India, companies have started mentioning ESG disclosures in annual reports. International investors investing in Indian listing entities often form their investment decisions based on ESG. The pandemic has made people even more aware of the need for adaptable strategies.
While there are record-breaking inflows from people wishing to see a better tomorrow, it is important to note that companies can be deceptive. For instance, if a company has a low E score but somehow manages higher S and G scores by making charitable donations or employing a few people from minority communities, on the surface it can appear “sustainable”. This could seem to have no major issues and in turn, start appealing to people as “flawless”. However, this can be avoided when one makes close observations.
Some critics say that applying non-financial indicators like ESG must result in lower investment returns since the number of opportunities is reduced. Some SRI supporters argue that ESG integration delivers meaningful returns. The third school of thought is that under normal circumstances, there should not be any major differences between the long-term performances of a broad range of traditional funds and a broad range of SRI funds.
Since sustainable investors believe in the long-term values and personal priorities, they are likely to stay invested even when performances are poor, while on the other hand, other funds see massive sell-offs. Sustainable investment opportunities can even help in establishing a deeper connection between clients and customers.
A recent study by Morgan Stanley compared returns for 10,000+ funds between 2004 and 2018. It was found that there was no financial tradeoff at all between impact-focused funds and their traditional counterparts.
Sustainable practices have the potential to make a company less vulnerable to issues like ethical scandals. ESG is believed to be good for businesses in the long run. Even though impact-oriented funds have been more expensive than their counterparts, with their rise in popularity, major fund companies are combating the price war, the difference shrinking with passing time.
No one size fits all, and only when both proponents, as well as opponents of sustainable investment, see beyond rigid ideologies can they get a broader as well as clearer picture.
Author’s Profile: Ritu is a 10th grader from Kolkata. She has an appreciation for literature, music, and basketball.