We’ve seen a rise in Environmental, Social and Governance (ESG) investing trends in 2022, and it’s not slowing down any time soon. According to Bloomberg, ESG assets will hit $50 trillion in the next three years. This figure represents more than a third of the projected $140.5 trillion in global assets.
Fund managers and investors corroborate these figures and agree that ESG investing will only grow from this point and beyond. Companies continue to see the business value of sustainability investing, and investors expect competitive yields and require assurances that these companies stay true to ESG metrics. This blog tackles the future of ESG investing, its risks and benefits and its potential profitability. We assess if there is an increase in ESG investments and if it makes a difference for small and big companies in the market.
Challenges in ESG Investing
One of the biggest problems for investors concerning ESG investing companies is the need for more transparency and reliable audits that show proper disclosure and clarity in their goals.
Measuring financial performance is more straightforward than identifying the myriad of issues in ESG. Let alone measuring each of them with a plethora of qualitative and quantitative standards in the market can distract the focus on more relevant issues that genuinely affect a company’s ESG performance.
Another problem for investors is the need for more agency where their investments are being funneled to or if these funds are truly making a difference in the various aspects of ESG. These problems stem from a lack of general criteria or standards that would help enhance disclosures, increase transparency and provide a clear framework with the potential to truly address climate, social and governance issues.
The Benefits of ESG Investing
One of the biggest problems for investors concerning ESG investing companies is the need for more transparency and reliable audits that show proper disclosure and clarity in their goals.
Measuring financial performance is more straightforward than identifying the myriad of issues in ESG. Let alone measuring each of them with a plethora of qualitative and quantitative standards in the market can distract the focus on more relevant issues that genuinely affect a company’s ESG performance.
Another problem for investors is the need for more agency where their investments are being funneled to or if these funds are truly making a difference in the various aspects of ESG. These problems stem from a lack of general criteria or standards that would help enhance disclosures, increase transparency and provide a clear framework with the potential to truly address climate, social and governance issues.
The Benefits of ESG Investing [H2]
ESG investing is a type of investment strategy that focuses on environmental, social and governance factors and entails purchasing the equity or debt of sustainable companies.
Over the year, ESG investing has seen considerable growth because of the following considerations:
- Social awareness of important issues, such as human and labour rights and global risks due to supply chain complexities.
- Climate change concerns and the increasing frequency of abnormal weather events.
- Those in the younger bracket of the investing population are highly engaged in environmental, social and governance issues.
These growth factors are further enhanced by the primary benefits of ESG investing, which are:
- Low risk—Companies with sustainable practices and follow an ESG framework are more likely to be low risk, and these companies are where ESG investors thrive. Investors will avoid companies with questionable practices as they’re more likely to fail in the long run and are also unsustainable. This means that their stocks will likely sell at a low price when it comes.
- Cost-effective—ESG-compliant companies with sustainable practices are cost-effective in the long run as they divert finances on more significant areas of their operation, require less advertising and limit their purchase of luxury items for those in executive positions.
Higher returns—ESG investors expect higher ROI in ESG-compliant companies because of better sustainability and business practices. This is due to better market shares, excellent reputation and increased profitability.
Risks Involved in ESG Investing
There are multiple reasons ESG matters for some investors, and it could be from different viewpoints, such as financial, competitive, wise and strategic standpoints. Ultimately, the main reason is that ESG investments are a more stable and safer bet in the long run.
Here are a few risks that investors consider:
- Long-term risk and asset devaluation—Climate change and other environmental effects directly affect companies, leading to property and infrastructure damage. This is why investors include in their ESG profiling a company’s preparedness and ability to forecast and respond to environmental threats.
- Transition risk refers to risks during transitions to policies, regulations and laws prioritising and addressing environmental, social and governance factors, such as improving hiring measures to be more inclusive and diverse.
- Litigation risk—Companies that do not lower CO2 emissions or contribute to pollution and other environmentally destructive habits and practices are liable to class-action lawsuits and legal issues. Investors are keen on avoiding these companies and will likely not include them in their portfolios.
- Physical risks—These risks consider acute and chronic threats that companies can factor in during financial planning to mitigate losses and prepare better. Acute hazards include droughts, floods and forest fires, whilst common threats include biodiversity loss, rising sea temperatures and emerging diseases.
- Social and governance risk events—The volatile geopolitical landscape and emerging conflicts, such as the recent Ukraine-Russian War, can lead to halting production and distribution and affect companies and investors. Treading on thin ice in these situations can be risky, but investors expect companies to uphold public trust and maintain positive, healthy and ethical relationships with stakeholders and shareholders.
What Is the Future of ESG Investing?
Technology is one of the drivers of innovation in ESG reporting and compliance. Artificial intelligence-driven tools and blockchain technology are changing how data analysis and collection work, ensuring that data is more accurate and trustworthy.
The improvement in data quality provides an avenue for better and more accurate ESG investment models, which give investors a more precise insight and understanding of the impact of their investment decisions.
Let’s look at some of the beneficial outcomes of ESG investing and how this will change over the years:
- Data Accurate ESG Ratings—More accurate data points will improve real-time analysis of a portfolio’s ESG rating, which helps investors make informed decisions and better assess if they funnel their investments to the correct portfolio.
- Direct Indexing—This type of ESG strategy could help investors have more agency over the causes and values they wish to fund, empowering personalisation whilst creating a positive impact.
- Investment as a Service Platform—These digital investment advisors have ESG settings and offerings that an investor can tweak in line with their ESG perspectives and goals.
- ESG Penalties—Whilst still not currently implemented in most settings, some investors place penalties on companies that don’t meet ESG goals or do not provide solid proof or evidence of ESG performance. This discipline check ensures that companies comply with their goals and reduce ESG risk providing a win-win situation for all parties involved.
These are just a few improvements and strategies that are gradually seeing implementation in various ESG-compliant sectors and will continue evolving as better data analysis tools and standardised metrics emerge.
Is ESG Investing Profitable?
Whilst the data isn’t clear due to subjective approaches in ESG and the various standards to measure its different aspects, the consensus is that ESG has a high potential for profitability. As more companies embrace ESG compliance and non-financial reports, they’re looking to draw in investors with the same mindset and principles. They want to work towards building a sustainable business environment whilst practising good governance and protecting human rights.
The ESG framework and investment are projected to stay for a long time and will determine how companies operate in building sustainable practices whilst increasing profitability. Some companies and investors are still hesitant and think ESG is only a fad; however, the call for addressing ESG factors is louder than ever, and corporations are starting to heed these calls and transition to better regulations and policies.
How Madison Marcus Can Help You
For more ESG and sustainable investing and concerns, you can consult with us at Madison Marcus. We have experts to address your legal needs and provide you with the best solutions.
For all enquiries, contact us here.
