What is needed now for ESG investing?

It also has plenty of opportunities, such as a rising cohort of younger investors interested in sustainability, greater access to online tools and information, and the prospect of strong adviser-client relationships.

But what does ESG need to make sure that it is a long-term, sustainable investment philosophy, and not just a popular fad for the short term?

For Ashley Hamilton Claxton, head of sustainability at Royal London Asset Management, behavioural change has to be one of the key priorities for encouraging and solidifying ESG investing, as much as it is for combating climate change. 

Companies that are deemed to be acting responsibly on social and environmental issues will have stronger brands than those that don’t.Stuart Dunbar

She says: “We cannot solve the climate crisis without a sociopolitical solution. It’s about behavioural change and incentives, not simply environmental and technical challenges.”

Baillie Gifford partner Stuart Dunbar agrees. He explains: “Social pressure and changes in how we personally interact and behave will play a role, for example potentially reducing the need and desire for travel, and for carbon and water-intensive farming.”

Younger generations

From Dunbar’s perspective, these behavioural changes are led by a ‘partnership of hope’ between the younger generations of today – emerging investors and stakeholders – and the companies that supply and serve our society.

He says this partnership will result in companies actively making a difference to their products and services, not just in terms of pricing but also their ESG impact. 

Dunbar explains: “A generation that has grown up with an understanding of the realities of climate change is maturing, and becoming more significant as a driving source in consumer spending. 

“Companies that are deemed to be acting responsibly on social and environmental issues will have stronger brands than those that don’t.”

His comments have been backed up by a new survey from law firm Gowling WLG. 

Carried out among more than 1,000 Generation Zs (16-25 year olds), the ‘Tomorrow’s World’ study warned of the danger of not properly engaging with Gen Z on ESG.

The report revealed that, as citizens and community members, Gen Z is more aware, more influential, and more likely to take action on ESG issues than any other generation.

The report found:

• Gen Z (16–25 year olds) are hyper aware of corporate ESG issues: 87 per cent said they consider suppliers when deciding how ethical a business is.
• 3 in 5 Gen Zs will protest about businesses’ perceived ESG failings on social media and on the streets.
• Gen Z demands high financial penalties for environmental infringements: 28 per cent said offenders should face fines of 11–20 per cent of their turnover; 20 per cent said that should rise to 30 per cent. 

But companies cannot simply turn green and pass the costs of doing that onto the consumers. Dunbar emphasises that affordability is key, and companies that “externalise the long-term costs” onto society will “be penalised” in how consumers – and investors – make decisions with their money.

In order for companies to thrive in the future, they will need to appeal to the emerging, ESG-savvy generations of spenders and savers. Therefore, without a proper, long-term approach to sustainability, the companies themselves cannot sustain their own profit growth.

Vision and intent

ESG is also about a vision, and that vision – a Venn diagram where environmental and social concerns marry with investors’ financial expectations and goals – is the wellbeing of both the planet and portfolios. 

For Eugene Krishnan, chief financial officer of US digital health organisation Jaan Health, keeping that vision of a better future for humankind and the planet should be paramount for individuals, but it also comes down to having a clearer idea of what governance means as part of that ESG package.

He thinks it is important to hold on to that vision, with clarity and intent in corporate governance being the driving force behind effective and impactful environmental and social action. And investors large and small need to make sure that engagement is maintained to help drive positive change. 

It’s about helping them make an informed decision.Tim Morris, Russell & Co

Krishnan says: “It is about asking the right questions, keeping the dialogue engaged with the right intent in mind, and there are different intents. With ESG, governance is laid on top [of a company’s purpose].

“The environment is about conserving nature’s resources so that we have a good place to live for all human beings, for a long time.

“The social constructs are about making sure that our social enterprises are set up so that they are not disadvantaging or hurting anyone.”

If companies can get all three things in place, and investors hold them to account, that vision for a better future for humanity and the planet can align with financial end goals. 

Open, honest dialogue

For Tim Morris, IFA for Russell & Co, open and sensitive dialogue needs to happen with clients more widely, and there has to be as much transparency and clarity as possible in conversations.

“It’s about helping them make an informed decision. This can include approaching sensitive topics, such as what drives their beliefs.

"Generally, this makes for a more engaging and enjoyable conversation, and gives good insight into what really makes your clients tick,” he says.

But dialogue must go further than just with clients. Dunbar feels that stewardship is multidimensional, and happens within companies, in the daily interactions that take place between investors and companies they are considering investing in.

All roads lead to disclosure.Steve Nelson, the lang cat

For Baillie Gifford, engaging with boards is a massive part, and admittedly resource-intensive aspect of how they gear their work in an ESG-compatible direction.

He explains: “In terms of day-to-day application, identifying good governance is about understanding what companies are doing, what is motivating their behaviour, management, timescale and capacity.

“It is also about the need to understand what companies are interested in and coping with. What is motivating them? What kind of capacity do they have?”

Dunbar feels that the transition and process of change is of high importance. He points out that, sometimes, some of the companies traditionally thought of as ESG offenders do in fact hold the tools, such as infrastructure, to roll out and maintain effective alternative solutions.

An inclusive, engaged approach

Therefore, rather than exclude or screen out these companies, many fund management groups tend to engage with investee and potential investee companies.

Managers collaborate, have conversations and gauge where the companies are in terms of progress and plans, and what their intentions and capacity for change are.

Sometimes, this takes a long time – and an element of realism and understanding is needed. Dunbar comments: “To facilitate the carbon transition, for instance, we still have to dig up iron ore, as we need that to build the turbines.

“Therefore, it is wildly simplistic to say I will create you a ‘low-carbon portfolio’ by not investing in these highly intensive and somewhat polluting companies.

“It is much more difficult, but much more effective, to invest in those companies who are least environmentally damaging but participating in the carbon transition.”

Dunbar says that for ESG investing, it is “the process of change that matters, not the carbon snapshot of data”.

At their best, many of today’s ESG strategies merely minimise harm on the environment.Jack Chellam, Global Returns Project

He adds: “Somebody is going to have to keep making steel, but those companies who are doing it in the least damaging way are likely to be on the right side of regulations, and that’s the opportunity.”

Steve Nelson is insight director at the financial consultancy company the lang cat. Asked what he considers necessary for successful ESG implementation, when it comes to developing technology such as platforms and data-driven tools, Nelson says for him “all roads lead to disclosure”.

“Where data standards improve and work alongside reporting tools to shine a light on what’s going on under the bonnet of investment portfolios, this in turn will help inform better conversations with those clients who choose to engage in the subject.”

Giving people a leg-up

On a more macro level, Dunbar offers a final thought: “It’s important to remember that the social and the environmental are intrinsically linked: people who are socially disadvantaged or in countries with low levels of income are often simply not in a position to pay higher prices for more carbon-friendly business practices.  

“All else being equal, this suggests that a greater focus on distribution of income (both domestically and internationally) is also necessary to accelerate global progress on tackling climate change.”

For clients just starting out on their ESG journey, or perhaps for younger investors who do not have much in the way of savings, one method of redistributing income is endorsed by Jack Chellman at the Global Returns Project.

This is an initiative encouraging all savers to donate 0.25 per cent of their savings to not-for-profit projects targeted at environmental regeneration.

Chellman states: “At their best, many of today’s ESG strategies merely minimise harm on the environment. Embracing directly regenerative strategies increases the likelihood of real and identifiable results for the planet.

“Doing so is also a rational investment strategy – all investments are less risky when we enhance and protect the biosphere.”

He says ESG investors are ready for innovation – for thinking out of the box about how to deliver the best impact for the planet. “Incorporating a small contribution to climate not-for-profit work into an overall ESG strategy for example, goes beyond traditional ESG to support truly regenerative solutions,” he adds.

It is clear that ESG is a hugely broad and nuanced area of investing. Its potential can often be masked by greenwashing, offloading responsibility for change-making between different parties, and current regulatory limitations.

Not to mention there is still a limit in terms of knowledge and understanding of what exactly is needed to improve ESG investing for all parties. 

However, there is hope. By keeping dialogue open, each stakeholder playing their part and taking responsibility, and a sociopolitical, collaborative approach between investors, advisers, fund managers, investee companies and policymakers, ESG investing can make a difference – protecting profits, people and planet in the long term.