Asset Classes and Strategy

Three key factors are used to measure the sustainability and societal impact of investing in a company – Environmental, Social and Governance, or ESG. By incorporating ESG factors into investment decisions, portfolios can potentially better manage downside risk and generate higher risk-adjusted returns over time.

Companies that embrace ESG tend to gain a more loyal customer following. For example, customers are more likely to buy from companies that recycle waste materials to make new goods, in order to reduce their individual carbon footprint. These companies also tend to avoid issues that may result in reputational damage, drawn-out lawsuits and fines that come from ESG-related violations, which are risks that can impact shareholders’ returns.

Investor interest in ESG factors has grown rapidly since the COVID-19 outbreak. For example, 71% of institutional investors ⁴ globally plan to integrate ESG into their investment process by 2030. This heightened interest has led to ESG-strong companies becoming expensive, but this valuation continues to remain supported by a clear technical uptrend.

This interest is likely to lead to ESG-related managed assets growing from an estimated US$30 trillion in 2020 to US$160 trillion by 2036 ⁵  and a significant increase in sustainable debt issuance (Figure C1) – both of which will likely accelerate as interest grows.

There are risks that investors should be aware of, however. For example, while there are genuine ESG-strong companies, there are also those that may conduct ‘greenwashing’ – providing misleading information on the friendliness of their environmental policies. In addition, companies that embark on the ESG path might need to invest significantly in the near term – this will impact their immediate cash flow and profitability, in order to benefit over the longer term.

While Europe and the US are more advanced in ESG investing and regulations, Emerging Markets such as China, Brazil and India are rapidly catching up. Companies that adopt ESG business practices early will likely benefit as governments are likely to implement more stringent climate-friendly regulations over time.

There are also clear financial benefits of this trend for long-term investors. For example, green bonds can be issued at a slightly lower yield than comparable bonds, giving companies with strong ESG practices access to cheaper funds. Such companies will also gain the attention of investors through their responsible practices, thus attracting greater investor interest.