Why ESG is a Business Investment

By Emmeline De Chazal, ESG specialist at e-learning compliance training firm, Skillcast.

ESG has become a catch-all phrase describing a firm’s moral considerations. Demonstrating high standards of ethical conduct in business and a commitment to sustainability and social justice is a trend that is on the up. However, there is more to the ESG buzz than meets the eye. A response to this movement equates to an investment for firms.

The drive toward ESG

Environmental impact, Social purpose and Governance (ESG), as a concept, has impacted financial service businesses over the past few years. The principles of ESG are likely to continue gathering momentum.

Whether the driver is investor demands, shareholder pressure, or the need to keep up with competitors, ESG will be one of the main factors influencing business change in the immediate future.

Another factor in the drive towards ESG is climate change’s ever-increasing threat of financial risk. This threat is particularly important to insurers who want to protect themselves from the risk of damage to physical assets due to fires, floods, etc.

Investors and customers are generally the first drivers in moving toward more ESG-focused policies. The trend toward “ESG-savvy” investors is increasing, and fund managers have responded by providing more investment options focused on sustainability and ethical practices.

Challenges for management

The challenges for managers are not necessarily around selecting businesses and assets that meet the necessary criteria regarding their environmental and social stances. Investors will not only continue to demand strong returns but will expect asset selections for the longer term rather than the short term.

Managers still need to apply appropriate due diligence to their stock selection processes and avoid picking investments because they meet certain ESG criteria at the time. The key is to avoid creating sustainable funds for the sake of creating them. This ultimately risks failure in a few years due to persistently poor returns.

Establishing a competitive advantage with ESG

A paper produced by Harvard Business Review stated that sustainability practices have a habit of converging over time, making it difficult to stand out from the crowd.

Based on this assessment, ESG will cease to exist as a distinct concept with time. Instead, it will become a part of the business DNA. However, this does not mean firms cannot generate short-term benefits by anticipating future movements in investor preferences regarding ESG.

One of these preferences is having an ESG policy in place. Firms should consider building this type of policy and leveraging the continued growth in ESG awareness. The core question is: can offering products or investments based on sustainability be a solid foundation for a future business strategy?

The answer lies in whether adopting an ESG stance is done to keep pace with the competition or leveraged to create a genuine distinction between business competitors.

ESG investment is definitely in a growth phase, with almost three-quarters of millennials interested in investing in businesses with the right approach to ESG. Having an ESG focus is set to give businesses an edge today, tomorrow, and in the days down the line.

An ESG policy is future-proof

The challenge is to tap into this ESG demand, at least in the short term. For some firms, this may be analysing possible gaps in market propositions relating to ESG, such as those in hedge funds or other structured products.

Potential growth areas could include Real Estate Investment Trusts with a specific focus on social impacts (i.e. the needs of tenants and local communities). Other opportunities may lie in the continued interest in specialist funds with a particularly narrow ESG focus, such as those promoting low-carbon growth or reducing activities.

ESG is here to stay, and an ESG policy is invaluable to a business. Whether the motivation is a fear of missing out or a desire to build value propositions proactively, firms need to think about how ESG considerations will influence their internal practices and how they can position themselves to their investors and clients.

The road ahead for ESG

ESG strategies address climate change concerns more closely, promote fairness or provide more disclosures in annual reports about these activities. No firm can avoid these three areas.

Business reputations can be affected by engaging in local, national, and global initiatives. The concept of social responsibility is only going to increase in future. Retail clients, investors and analysts alike will be taking careful note. Therefore, attention to ESG matters cannot be undervalued.

ESG is predicted to feature more prominently in future business and governance models and policies – the influence filtering from the boardroom to the product design, marketing and communications teams. Its influence won’t stop there – the impact of ESG is set to be felt in control functions, such as risk and compliance.

To sum up, ESG needs to be thought of as more than a fad or a buzzword but as a normal and integral part of how business is carried out in the future. The quicker firms respond to this movement towards ESG, the greater the business investment value.