The investment power of ESG

In investment terms, ESG is now unignorable. It’s an alpha driver.

Just look at the latest report by the CFA Institute, the global professional organization for investment professionals.

It shows that 100% of institutional investors and 77% of retail investors are either interested in or already using ESG (Environmental, Social and Governance) strategies.

Higher risk-adjusted returns are the main focus of institutional investors, says the CFA’s Enhancing Investors Trust Report 2022.

But they are also motivated to invest in companies that have a positive environmental or societal impact. Their top areas of concern? Data protection and privacy, sustainable supply chain management, and climate change.

This is backed by the OECD. It reports that the growth of ESG-related traded investment products available to institutional and retail investors now exceeds $1 trillion. And the numbers are growing fast across all major financial markets. In other words, the rules for responsible investing have changed.

Investing can no longer be defined by whether a fund manager outperforms the benchmark.

The bottom line is now the alignment of positive financial returns with lasting positive outcomes for society. That means ESG is now a powerful driver for both risk-adjusted alpha and greater good.

And the hidden alpha in the intangible value that ESG represents? For investors there can be significant value owning companies that are misunderstood from an ESG perspective.

But factoring in ESG into investment is also a powerful and prudent risk-prevention strategy.

Recent industry and academic studies show this. ESG investing can help improve risk management and lead to returns that are superior to returns from traditional financial investments.

The rise in prioritisation of ESG has followed the coronavirus pandemic. The health crisis focused hearts and minds on the interconnectedness of sustainability and the financial system.

So, what is a good ESG stock? There’s no standardised approach to the calculation or presentation of different ESG metrics. But well-regarded ESG rating agencies, such as Bloomberg, S&P Dow Jones Indices, JUST Capital, MSCI and Refinitiv, are the main go-to for institutional investors.

These show whether a company has a history of aligning its operations to support programmes benefiting the environment, employees, local communities, and shareholders, based upon verifiable history.

MSCI, for example, evaluates companies holistically. It looks at their exposure to, and management of, material ESG risks in their industry. The scale ranges from AAA to CCC, and the leading ESG companies in each industry receive an AAA or AA ranking.

JUST Capital publishes rankings, investable indexes, and in-depth financial analysis to support the business and investor case for ‘just’ business behaviour.

Companies get evaluated across a range of metrics in these categories:

• Workers: how a company invests in its employees (39% weighting).

• Communities: how a company supports its communities (20% weighting).

• Shareholders and governance: how a company prioritizes good governance (19% weighting).

• Customers: how a company treats its customers in areas such as data privacy (11% ranking).

• Environment: how a company minimizes its environmental impact (10%).

JUST Capital’s JUST U.S. Large Cap Diversified Index (JULCD) tracks the performance of large, public companies with high ESG scores.

It includes 50% of the large-cap public companies in the Russell 1000 index. But it excludes companies that lack a demonstrated commitment to issues such as the well-being of employees, beneficial products, positive environment performance and strong communities.

Its performance? JUST Capital’s JULCD index has just outperformed the Russell 1000 for three years in a row.