Interest in ESG (Environmental, Social and Governance) investing continues to grow. In our 2019 client insights survey, approximately 80 per cent of clients told us that they were interested in sustainable investing – and have either invested or were intending to do so.
ESG investing is focused on both protecting and enhancing long-term financial value, as well as contributing towards addressing environmental and social challenges.
As investors consider this, we bring three practical investment tips, inspired from observing the behaviour of rats - the Chinese zodiac animal of 2020.
"ESG investing is focused on both protecting and enhancing long-term financial value, as well as contributing towards addressing environmental and social challenges. "
1. Don’t follow the herd
Rats are vulnerable to peer pressure and this usually gets them into trouble. Remember the legend of the Pied Piper?
Sustainable investing has gained a lot of media attention and people are increasingly using social media to share their views on various related topics. It is important to not lose sight of your personal goals in the pursuit of doing good through investing.
Within sustainable investing, there might be areas of environmental or social issues that you are more interested in and see an opportunity to capitalise on macro trends – from water and sanitation to investing in the broad sustainable development goals. Starting with your areas of interest rather than following the herd is always a good first step.
One of the misconceptions around sustainable investing is that it is driven by the ‘heart’ and that ESG investments underperform. In a study comparing over 10,000 funds between 2004 – 2018, it was found that sustainable funds provided returns in line with comparable traditional funds while reducing downside risk. It is always prudent to ask questions about the financial performance of the investment before committing your funds to it.
2. Ensure all rat holes are plugged
An adult rat can squeeze into your home through a hole as small as the size of a quarter. It is critical to spot rat holes in floors and walls to keep them out of your homes.
Looking at ESG issues allows us to address some of the rat holes so that risk is better managed in one’s portfolio for the long term. The same research above above showed that sustainable funds had 20 per cent less downside risk than traditional funds, and were more resilient in years of turbulent markets, such as in 2008, 2009, 2015 and 2018.
One potential rat hole is climate risk – which is the E (environment) in ESG. The Bank for International Settlements (BIS) recently warned that climate change may spark ‘green swan’ or ‘climate black swan’ disasters, that could trigger a systemic financial crisis.
The number of extreme weather events has quadrupled over the last 40 years. Only 44 percent of the climate-related financial losses are covered by insurance in the United States. Meanwhile, in Asia, only eight per cent and in Africa only three per cent of climate-related financial losses are covered.
Other rat holes may include ESG issues in either the governance (e.g. accounting scandals and data breaches) or social (e.g. sexual harassment, labour rights infringements) categories of ESG.
A 2019 study showed that ESG controversies wiped out significant value in US companies embroiled in ESG-related issues over the last five years. ESG controversies together resulted in peak-to-trough market value losses of $534bn as the share prices of the companies involved sank relative to the S&P 500 over the following year.
3. Chew on it and dig deep!
Rats are known for constantly chewing as their incisors never stop growing! It can grow up to about 13cm per year and can chew through glass, lead and even aluminium.
With increasing concerns around green washing or ESG washing – where an investment manager’s claims of ESG integration could be exaggerated or misleading – it would be wise for investors to probe deeper into the ESG solutions being presented to them.
Since ESG is not yet a highly regulated space and there are no common standards, many funds could technically be labelled ESG as long as sufficient disclosures are made in fine print. The International Monetary Fund estimates that there are now more than 1,500 equity funds with an “explicit sustainability mandate”. According to Morningstar, asset managers launched 360 sustainable funds last year, with 50 of the new offerings having an explicit climate-oriented mandate. Many asset managers are converting existing products into sustainable funds in response to client demand.
If you are considering investing in an ESG fund in the year of the Rat, areas to gnaw at include probing on exclusions of certain controversial sectors, the sophistication of ESG strategy of the fund, expertise of the team and how well environmental, social and governance factors are being integrated as part of the overall investment process.
This article has been provided for general information purposes only, it does not take into account the specific investment objectives or financial situation of any particular person or class of persons and it has not been prepared as investment advice for any such person(s). Further details can be found at the disclaimers here.
A version of this article originally appeared in The Sun, Malaysia on 17 February 2020.