ESG investing: the future for private equity?

Ethics and investing have not always gone hand in hand, and the topic can often leave investors in a tough predicament.

On the one hand, we need investments to fuel wealth, achieve financial objectives and progress the modern world, but on the other hand, certain investments can pose challenges to ethical issues.

Recently, we have seen the rise of ESG investing, an approach that considers not only the financial gain of an investment, but also the impacts it has on the wellbeing of others. It has proven to be a very meaningful strategy, but it does also have its shortcomings.

In this article, I will delve into some of the key benefits and limitations of ESG investing, formulating an opinion as to whether ESG will gradually become a core consideration for all investors.

What is ESG Investing?

Traditional financial models have tended to focus almost exclusively on profit. However, as generations have become more aware of social and environmental issues, investors have started to support only those companies that align with their own values.

This approach is broadly referred to as “ESG” (Environmental, Social and Governance) investing - the factors considered when determining the ethics of a company’s operations.

Environmental criteria may include a firm's energy use, waste, pollution, and treatment of animals. Social factors include human rights and a company’s business relationships. Governance refers to diversity, and how a firm manages those at the top.

ESG investing involves analysing these three considerations and incorporating the findings into financial models.

Benefits & Limitations of ESG Investing

The strongest benefit of this strategy is that it often provides investors the chance to reach their financial objectives, whilst simultaneously supporting their values. This has proven increasingly popular, with sustainable mutual funds growing significantly over the years.

To me, this is extremely encouraging – who doesn’t want to do good and make money in the process?

However, just like anything else, ESG does have limitations, making it more complicated than first meets the eye. For instance, it is not a standardised approach – investment firms use varying criteria, and so ESG scores for the same company can differ drastically.

Additionally, ESG investing poses some financial limitations to the investor, with ESG funds generally being more expensive than standard. Strict ESG criteria can significantly limit the diversification of an investor’s portfolio, as there is usually a much smaller pool of firms to choose from. This also leaves investors heavily exposed to the unique risks of those companies.

These cons make a seemingly easy decision between ethical and traditional investing a bit trickier.

The Future of ESG Investing

Whilst the shortcomings of ESG are apparent, we are seeing an increasing number of firms adopt ESG principles, clearly viewing the benefits as outweighing the cons and costs.

For example, HSBC Global Asset Management announced last week that it would be taking its ESG responsibilities just as seriously as its financial. They are now committed to incorporating their ESG performance into their annual reports and results. 

Additionally, two of the world’s largest asset managers, Blackstone and Blackrock, both openly recognise their unique positions to make a positive impact through their investments. Both are committed to responsible investment practices and have released a range of ESG products.

Global Infrastructure Partners are extremely proactive in ESG, embracing the criteria throughout the entire life cycle of their investments.

Further, several investors are signatory to the Principles of Responsible Investment Task Force, such as KKR and Vantage Infrastructure, recognising the link between this and the performance and reputation of their investments.

Conclusion

At the beginning of this article, I posed myself the question – will all investors begin to incorporate ESG considerations?

I think the notion of “all” investors, may be too farfetched for now, but I do think it is fair to estimate that we will see a significant increase in the coming years.

Ethical investing remains a relatively controversial topic – some professionals believe that the profitability of projects is the main priority, others believe that investors have a duty to support firms that will have a positive impact on the world.

Needless to say – there are still many grey areas of ESG, where even the most ethical of investors disagree. But, at the very least, taking the extra step to consider ESG factors is something that should not only help you align your holdings with your values, but it might just lower the risk of your portfolio as a whole…

If you would like to find out more about ESG investing or looking for an opportunity in ESG investing, please feel free to contact me on Lianna McDonald lmcdonald@leap29.com.

 

Posted by Lianna McDonald