Why ESG investing needs to become the New Norm

This article is in collaboration with Leeds Finsights, The Official University of Leeds Student Financial Publication.

With the proliferation of phenomena such as climate change and inequality Ben Harris, a Leeds Finsights analyst, explains why investors need to take into consideration the environmental, social, and governance impact of their investments.

The global allocation of capital in financial markets is still strongly weighted against global interest. This needs to change; we don’t have much time, as atmospheric C02 levels rise humanity is under more threat by the day. Saudi Aramco, Saudi Arabia’s state oil company is the most profitable company in the world. Making a reported $88211M net profit in 2019. Many of China’s state-owned enterprises are making similarly large profits with equal disregard for the environmental and social impacts of their actions. The most profitable investments are rarely ones that regard the long-term interests of all stakeholders in society.

With climate change and its multifarious impacts on the global economy becoming an ever-truer reality by the day, can we really stop and allow capital to continue to flow towards the short-term interests of the World’s richest? I believe the principles of Environmental, Social and Governance (ESG) investing ought to guide a new way in which capital flows. ESG investing is an umbrella term for responsible investments that generate profit from sustainable and ethical companies.

I am not suggesting that we replace the profit incentive as a way for investors to allocate their capital. As this is how the great innovation and efficiency gains we see today arise. Rather, I am suggesting that we guide investments towards profits that are in the interests of all stakeholders. We need to change the way in which capital is allocated and therefore profit is created, to be beneficial for all in the long term.

Source: Credit Suisse

This does not mean shareholders will not make a profit, the capitalist economy we live in only allows profitable companies to thrive. ESG allows investors to create a positive impact with their money, whilst continuing to get a return on investment. Currently, market forces alone are clearly not enough to redirect capital flows away from companies damaging stakeholder interest. Therefore, I believe the core principles of ESG investing need to be integrated into capital markets – creating change fast.

This could be done in a variety of ways. For example, Triple Bottom Line accounting to include the social and environmental ‘costs’ of operating as well as economic costs. If government regulation made this a mandatory requirement for large companies, they would be incentivised to strive for the type of cost minimisations they do economically with social and environmental costs too. This would cause capital to flow towards companies that better respect the interests of stakeholders, as the more profitable companies will have accounted for all costs of operating.

This would make ESG investing easier to implement for investors due to higher transparency of full business costs. However, all this would require an internationally coordinated effort to create an immense paradigm shift in business that goes against the current interests of many of the worlds richest and most powerful.

Obviously, the change I’m suggesting above is a drastic one. However, many institutional investors, such as Credit Suisse, have started using ESG when making investment decisions. This is largely only due to the informal social control of people today expecting change. Furthermore, ESG investments have performed better during the Covid-19 crisis, proving more resilient and the volume of investments in ESG, although difficult to exactly quantify, have undeniably been rising rapidly.

Sources: Credit Suisse, BAML European Equity Strategy, Bloomberg, Morningstar

Many tipping points have been identified by the UNFCC (The UN’s climate change body) to be within the coming decades. Formal restrictions and regulations are needed now to change where capital flows. Finite resources are being used up and irreversible damages are being made to the very environment the economy is dependent on. All due to the inconsiderate and selfish nature in which some global companies operate today. Time is one thing we certainly have little of.

Source: Normative