How Are Investors Thinking About ESG?

How Are Investors Thinking About ESG?

January 17, 2023

The importance of environmental, social, and governance (ESG) initiatives within the market continues to thrive and has been further flourishing in recent years. As this trend accelerates, the relationship between a company’s ESG programs and future profit may attract an increasing number of investors who prioritize ESG initiatives in their portfolios.

Yet an abundance of ESG data and the lack of a standard methodology for factoring such data into an investment decision increases complexity for investor-driven ESG strategies.

Gunes Kulaligil, Managing Director and Co-Lead of the Structured Finance Practice in Stout’s Valuation Advisory group, interviewed two other professionals on the state of ESG among investors: 

Phuong Gomard

Phuong Gomard
Partner and Sustainable Finance Practice Leader, Mazars

Vesta Marks

Vesta Marks
Managing Director, Semper Capital Management, L.P.

Gunes Kulaligil: What’s happening in the investing market at the moment regarding ESG?

Phuong Gomard: Investors are looking for the transparent and responsible management of companies, and those investors are mainly concerned with long-term value creation through the security of their investments.

The security of investments increasingly depends on how sustainably companies act, and so investors need information on sustainability performance of potential investments or business partners that they want to engage with. This is so significant that companies that are unable to provide evidence of their sustainability could be excluded or not given the same interest by investment decision makers.

Sustainability also brings an added degree of safety to an investment decision and return. Security of an investment and its return are often seen as two opposing concepts, but that opposition is being negated in the eyes of those who are looking to invest sustainably. The two can go together.

Gunes: What are the key risks at the crossroad of sustainability and investment decisions?

Vesta Marks: When investors are demanding more and more sustainability in their portfolios, as an investment manager, choosing not to integrate sustainability into your processes means you’re inherently taking on business risk. ESG is a trend that is highly likely to persist.

At some point, ESG reporting will become more and more transparent to large investors allocating funds as to what investment managers are truly doing to integrate sustainability into their investment processes. There is a reputation risk for companies that may be leading people to believe they are taking ESG more seriously than they actually are.

If we truly believe that companies that have stronger sustainable practices reduce risk at the company level, that translates to investing decisions as well. For example, if you invest in companies that have poor sustainable practices, poor practices such as human rights violations, or environmental concerns, this could lead to fines that contribute to financial and reputational risk.

Gunes: What are the different types of investment strategies being adopted relating to ESG?

Vesta: This is still very fluid. But I see four broad buckets.

First, there’s impact investing, which is really the genesis of the entire ESG movement. This is where foundations or grant providers would have focused, centered on a concessionary return received and a high, measurable impact.

Second, there is thematic investing, which centers on investing in specific sustainable “themes.” These themes could include clean energy, eliminating food insecurity, or sustainable housing.

There is also an integrated approach, where ESG principles are integrated into a wider investing strategy with the main goal of delivering returns. Your investing strategy is focused on the top line, but you are reducing risk in your strategy and becoming a better steward of capital through integrating ESG principles and sustainability into your investment decisions. Over time, this will likely be the broadest strategy utilized, allowing asset managers to continue their work but integrate sustainable practices into their analysis. That seems to be the most scalable.

The final strategy is really just doing nothing. This is where an investment manager just ignores ESG. However, this introduces business risk. ESG is a persistent trend that is likely to shape the industry over time, and choosing to be left out is probably not a wise choice.

Gunes: How can one assess sustainability performance?

Phuong: The short answer is, we need data. But when we talk about sustainability data, what is it that we are truly talking about? What do we need to do sustainability assessment or performance measurements?

ESG disclosure/reporting rules that are emerging around the world are working to address the question of the availability of data to measure sustainability performance. At some point, sustainability reporting may need to be audited or independently assured to ensure investors that reliance can be placed on the information included in those ESG disclosures. However, the challenge remains that there is not yet a standard methodology that firms should be using to assess sustainability performance data they collect.

A lot of audited and unaudited information is currently made available, so we are not really lacking data. What we are lacking is clarity on how to assess the quality of that data, how much can be used, and how to process that data to come to an investment decision.

Guidance and stricter regulations are coming as it relates to ESG performance integration in business decisions, and trying to get ahead of the curve can be valuable. The earlier you prepare, the less of a chance you’ll be in an expensive position to catch up.

Vesta: Even if people have the same set of data, various interpretations of that data will drive different views. That’s what makes markets. It will be the same with ESG data. Once the data becomes much more usable, we will be at the point where various investment managers can have that same data available and incorporate that into their processes.

With that integration, they will then be able to substantiate their views on how each investment has various sustainable characteristics based on the data that they’ve assessed. Over time, this will continue to improve.