ESG debate: Can ethics improve your investment performance?

ESG debate participants

MB, Innovest Environmental and social factors have always affected investment. But the markets haven’t always had the skills, ability or desire to find out how those factors affect materiality. It’s evolving. Our ability to track environmental and social issues and their impacts is relevant to how sophisticated the tools are for markets to analyse them. As they get more sophisticated, those factors will be considered more relevant in determining the best picks for long-term return.

MB, Asria At this stage of an ageing bull market investors are overvaluing growth and undervaluing risk. ESG has become more relevant to long-term returns. There are more tools available for looking at it. It’s also defining the investment thesis. You can’t have an informed view on the price of oil if you don’t have a view on how China and India are going to organize around issues framed by climate change. For returns on energy efficiency investments, the long-term case in emerging markets is strong. However, it’s also influenced by the price of electricity and whether there’s a country-level consensus. Near term there is a better consensus in Germany than in China. Most Asian governments do not discuss the price of electricity with the public. Most European governments do. So the financial opportunity around certain investments on a three-year view is higher in some developed markets than in Asia.

RT, Axa IM Well-run corporations understand that if they do not manage material ESG or, as we call them at Axa IM, extra-financial factors, well, the company will be unable to deliver sustainable value. That doesn’t mean that every ESG factor is important to every company. The skill for directors and investors is to know which are the most material drivers of long-term value and risk, and focus on these.

JW, HSBC Well-run companies manage ESG issues as an integral part of the business. Sustainability and profitability over the long run go hand in hand. But what weighting does the market give? I’ve yet to see evidence that ESG factors can be identified in asset valuations, particularly on equities.

WVDB, Aavishkaar Goodwell That’s because there isn’t a track record yet. But risk is in the eye of the beholder. There are opportunities out there, and opportunities are the flip side of risk.

RT, Axa IM Our definitions and measures of risk may need to change! Is volatility a good measure of risk for a long-term investor who’s trying to meet liabilities 20, 30, 50 years out? Clearly, no. Is it the most dominant risk metric? Yes. Management consultants have shown that corporate boards don’t understand and manage well the material extra-financials that are important for their sector. For example, human capital management in the financial sector is critical, but how many firms actively manage and report on this factor? One sector where we see good progress is the mineral and mining sector, where we do now get reasonable data on health and safety performance. One of the encouraging projects linking better corporate reporting and better investment analysis is the Enhanced Analytics Initiative. Sell-side houses are incentivized by their buy-side clients to look at those issues. Goldman Sachs and Citigroup are starting to do comparative assessments, bring them into their valuation. Companies should report better, and buy-side analysts should pay sell-side colleagues to look at what’s important.

PM, ICMM At national level, governance is key in determining foreign direct investment. The flows of investment into the world’s 33 mineral-dependent economies have not been correlated with the availability of resources. That’s a common feature, but in some countries, such as Indonesia, the Philippines, Papua New Guinea, which are all resource-dependent, investments have been declining. At the same time investments in better-governed countries have gone up astronomically. Governance is of fundamental importance in determining where investment is occurring. Indonesia has a wealth of resources but multinationals that have invested there historically are concerned about governance, and they’ve gone to other jurisdictions. Chile is an example of a jurisdiction where economic reform and governance improvements have stimulated significant foreign direct investment.

ESG is a mainstream issue in mineral resources because the value creation process in resource companies is about who gets access to world-class resources and the ability to operate those securely and fully. That is all about good performance and what companies can offer the host community and government. They need a track record of securely, safely and responsibly operating. It is those things that differentiate companies, and get them access to world-class resources. This is fundamentally important in emerging markets because the most significant component of FDI is their resources sector.

JW, HSBC Weak governance is keeping capital flows from international companies away from certain countries. But that creates an opportunity for capital flows from resource-dependent fast-growth economies to fill that gap. Absence of governance is not stopping huge capital flows into Africa. How do you take the good work that leaders have done and move it to the laggards? Relevant and transparent reporting is key.