What Is ESG?

ESG-embedded companies respond better to internal stakeholders (think employees) and external trends. Basically, ESG integration means companies are better run, have higher returns, and thus, greater value.

“ESG” stands for a recognized system of environmental, social, and governance criteria by which investors and stakeholders evaluate a company’s performance and impacts. “E” (environmental) covers how a company manages the natural resources it uses and its impact on the planet’s natural environment. “S” (social) covers how a company treats its stakeholders, as well as how it responds and contributes to larger social trends. And “G” (governance) covers both the rules and policies a company sets for itself and how it addresses the policies, regulations, and laws of the jurisdictions in which it operates.

In this article, I’ll cover why ESG should matter to your company, track the upward trend in ESG-related investing, and review the proof points behind why investors increasingly prioritize ESG when making decisions.

WHY IT MATTERS: THE SOCIAL CONTRACT

A 2021 United Nations’ climate report declared a “code red” because carbon dioxide emissions are higher now than they have been in 2 million years, and since 1970, global surface temperatures have risen faster than in the last 2,000 years.[1] Businesses can and must play a critical role in dropping carbon emissions and avoiding knock-on effects like worsening weather and climate events, biodiversity loss, and mass human migrations and suffering.

These are the top ESG criteria that money managers sought in 2020 along with the percentage change since 2018 (US|SIF, 2020, p. 3)

Against this backdrop, an enormous wealth transfer is happening. Over the next few decades, $30 trillion (USD) will transfer from Boomers to Millennials in the United States, and over $40T globally. So far, investors have committed to divesting $39.2T from fossil fuels and, in Q1 2021, set an all-time quarterly record by pouring $21.5 billion into sustainable funds.[2],[3]

In the United States, there are 80 million Millennials. They comprise the largest part of the workforce, and 79 percent of them are loyal to companies that care about their societal impact. Eighty-six percent of this group is interested in sustainable investing, and 90 percent want it for their 401(K)s. The Millennial cohort works for, buys the products and services of, and invests in companies with robust, embedded ESG values and performance.

The social contract business has with society has changed. The Millennial cohort is voting with its dollars and labor, and ESG companies and investments are winning out.

INVESTING TRENDS FOR ESG

U.S.-domiciled ESG assets under professional management grew 42 percent in two years — from $12T at the onset of 2018 to $17.1T in 2020.[4] This growth equals one in three of total US assets under professional management.[5] Investors including institutional investors, money managers, and community investing financial institutions use ESG to research, analyze, and make decisions across portfolios totaling $16.6T, also a 42 percent increase since 2018.[6]

These are the top ESG criteria that institutional investors sought in 2020 along with the percentage change since 2018 (US|SIF, 2020, p. 5). Global trends mirror those in the United States with ESG-related investing equaling 36 percent in 2020, up from 20 percent in 2012.

HOW DOES ESG PERFORM?

Since 2018, trillions of dollars have poured into ESG investing, and the data analysis is just now starting to catch up. Still, the business case for ESG is empirically well-founded, as ESG is proven to handily outperform non-ESG companies and investments .[8]

Companies showing higher cash flow returns for companies with percentages of women in senior management. With 20% WiM (women in management), companies perform 1.91 percentage points (avg) CFROI than companies with less than 15% WiM. (Credit Suisse, p. 22)

On average, generalized ESG criteria and corporate financial performance (CFP) are positively correlated.[9] One meta-study, which reviewed over 2,000 ESG studies between the years 2000 to 2015, showed that over 90% found a “non-negative” relationship between ESG and CFP.[10] Another meta-study (2015 to 2020) found long-term alpha enhancement when focusing on ESG issue improvement.[11] That study also demonstrated that firms with strong ESG ratings had returns up to 3.8 percent higher (per standard deviation of ESG) in the mid- and long-term.[12]

Companies with above women in management (25%) and women on boards (20%) outperform companies with below-average numbers by 3 percent (Credit Suisse)

ESG investing also appears to provide downside protection, especially during economic and social crises,[13] as full ESG integration seems to perform better than negative-screened investments.[14] (Think investments that preclude sectors like tobacco, military hardware and firearms, and fossil fuels.) And studies also show that firms managing for a low-carbon future have better CFP.[15] In fact, for every tonne of CO2 emissions reduced, companies see an ROI of 10 to 15 percent.[16]

Companies measured in the Credit Suisse Gender 3000, over 20% of Women in Management (WiM), and on the LGBT400. Companies with more than 20 percent WiM and on the LGBT400 outperform.

Briefly, money managers and institutional investors have spoken. Robust ESG factors identify responsible, well-managed, and resilient companies that can survive long-term.[17]

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References

Friede, G., Busch, T., & Bassen, A. (2015, Nov. 9). ESG and financial performance: aggregated evidence from more than 2000 empirical studies. Journal of Sustainable Finance & Investment, 5(4), 210–233. doi:https://doi.org/10.1080/20430795.2015.1118917

Kersley, R., Klerk, E., Jiang, B., Carnazi Weber, S., Natzkoff, J., Kharbanda, A., . . . Zumbühl, P. (2021, Sept.). Research Institute the CS Gender 3000 in 2021: Broadening the diversity discussion. Retrieved Nov. 5, 2021, from CreditSuisse: https://www.credit-suisse.com/about-us/en/reports-research/csri.html?WT.i_short-url=%2Fresearchinstitute&WT.i_target-url=%2Fabout-us%2Fen%2Freports-research%2Fcsri.html

Marsh, A. (2021, Oct. 26). Investors in fossil fuels announce plans to divest $39.2 trillion. (Bloomberg) Retrieved Nov. 10, 2021, from BUSINESS STANDARD: https://www.business-standard.com/article/markets/investors-in-fossil-fuels-announce-plans-to-divest-39-2-trillion-121102600666_1.html

Quann, C. Q. (2018, December 10). Interested in Setting Science-Based Targets? First, Establish Your Business Case. Antea Group. https://us.anteagroup.com/news-events/blog/science-based-targets-business-case

Schreier, H. (2021, May 12). After The Pandemic: ESG Investing Trends For 2021 And Beyond. Retrieved Nov. 9, 2021, from Forbes: https://www.forbes.com/sites/halseyschreier/2021/05/12/after-the-pandemic-esg-investing-trends-for-2021-and-beyond/?sh=63a3b90567b7

Stankiewicz, A. (2021, Oct. 28). The Number of New Sustainable Funds Hits an All-Time Record. Retrieved Nov. 10, 2021, from MORNINGSTAR: https://www.morningstar.com/articles/1062299/the-number-of-new-sustainable-funds-hits-an-all-time-recordc

United Nations. (2021, Aug. 9). IPCC report: ‘Code red’ for human driven global heating, warns UN chief. Retrieved Nov. 10, 2021, from United Nations | UN News: https://news.un.org/en/story/2021/08/1097362

US|SIF. (2020). Report on US Sustainable and Impact Investing Trends 2020 Executive Summary. Retrieved Nov. 9, 2021, from US|SIF The Forum for Sustainable and Responsible Investment: https://www.ussif.org/files/US%20SIF%20Trends%20Report%202020%20Executive%20Summary.pdf

US|SIF Foundation. (2020). 2020 Report on US Sustainable and Impact Investing Trends. Retrieved Nov. 9, 2021, from US|SIF The Forum for Sustainable and Responsible Investment: https://www.ussif.org/files/Trends/2020_Trends_Highlights_OnePager.pdf

Whelan, T., Atz, U., Van Holt, T., & Clark, C. (n.d.). ESG AND FINANCIAL PERFORMANCE: Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015–2020. Retrieved Nov. 8, 2021, from NYU | STERN: https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf

[1] (United Nations, 2021)

[2] (Marsh, 2021)

[3] (Stankiewicz, 2021)

[4] (US|SIF Foundation, 2020, p. 1)

[5] (US|SIF Foundation, 2020, p. 1)

[6] (US|SIF Foundation, 2020, p. 1)

[7] (Kersley, et al., 2021, p. 31)

[8] (Friede, Busch, & Bassen, 2015, p. 212)

[9] (Friede, Busch, & Bassen, 2015, p. 225)

[10] (Friede, Busch, & Bassen, 2015, p. 210)

[11] (Whelan, Atz, Van Holt, & Clark, p. 2)

[12] (Whelan, Atz, Van Holt, & Clark, p. 7)

[13] (Whelan, Atz, Van Holt, & Clark, p. 3)

[14] (Whelan, Atz, Van Holt, & Clark, p. 3)

[15] (Whelan, Atz, Van Holt, & Clark, pp. 2, 3)

[16] (Quann, p. 1)

[17] (US|SIF, 2020, p. v)