ESG investing stands on solid foundations, underpinned by two quite distinct drivers – ‘value’ (risk/return) and ‘values’ (ethics).
Let’s deal with ‘value’ (risk/return) first. People invest in KiwiSaver to maximise returns and provide for their golden years. Investing ethically shouldn’t hinder that, and it doesn’t.
The cash tsunami flowing into ESG funds should increase the cost of capital for fossil fuel, tobacco and gambling companies. It should result in weaker demand for their shares and bonds, making it more expensive for them to raise new capital.
For the same reason, companies that take ESG matters seriously should enjoy stronger demand for their shares and bonds and therefore find it easier to finance projects.
ESG critics suggest that this means lower returns. But no, investors who care about ESG factors will not do worse than those who don’t care.
Critics rely on the flawed idea that a company can have a rock bottom ESG score and still operate a resilient, strong and growing business. Of course there are exceptions, but in my view, poor ESG scores are indicative of higher risk businesses. Over the long-term these will deliver in aggregate lower returns.
ESG investors believe their approach offers new tools to scrutinise companies in the same way as Benjamin Graham and Warren Buffet pioneered ‘value investing’ as an investment paradigm.
ESG tells us a lot about potential financial risks.
Consider a company lacking independent directors, hiding related party transactions and rewarding executives solely on short-term goals. Poor governance indicates a company unlikely to realise it’s potential. It’s bad for shareholders and other stakeholders.
This is also true of a company that places a low priority on environmental protections. Just ask BP which ended up with a US$65 billion environmental disaster in the Gulf of Mexico.
Conversely, a company that rewards employees with fair pay, good working conditions and ongoing training can expect higher productivity and lower staff turnover. Such practices can make a business more innovative and profitable. Just ask Salesforce, Microsoft or a host of tech companies that “get it”.
This is not wishful thinking. Work by the NZ Super Fund, Morningstar and McKinsey demonstrates that when it comes to investing globally, ESG can improve long-term returns and lower risk.
And now let’s move to the question of ‘values’ (ethics).
ESG critics argue it is the role of government to tackle issues like minimum wages and carbon emissions. They argue we don’t want companies to have more responsibility for solving pressing social and environmental problems, like inequality and climate change.
On this, I fundamentally disagree. We do want companies to have those responsibilities – using their resources and smarts to find solutions. Governments can’t legislate for innovation, for new technologies or for passion to solve challenges. Companies can create an environment where those things happen. And people increasingly expect them to.
Many want to spend their money or invest their savings to positively impact the world. If someone doesn’t want to buy goods made with child labour, that’s their choice. If investing in the company using child labour feels like enabling unethical behaviour, that’s their call.
Whether it’s gambling, animal testing, tobacco manufacture or power stations burning coal, everyone has different views. This “values” part of ESG investing is personal.
That’s why it’s a good thing there are around 30 KiwiSaver providers who invest with different value sets. You can have tobacco and weapons in your KiwiSaver if you want. The responsibility of KiwiSaver providers is to be fully transparent and make it clear what value set, if any, they embed in their investing. To be fair, some managers do a good job around transparency, others not so good.
In a perfect world, shareholder and social interests would always align. That’s not reality, our world is far from perfect. However, ESG investing can and does generate good outcomes for investors and the planet. That’s why it must be the future.
John Berry, CEO of CareSaver KiwiSaver managed by Pathfinder Asset Management.
This is an abridged version of John’s article which the NZ Herald kindly published as a reply to an earlier article from Financial Times columnist Robert Armstrong that was critical of ESG investing. We greatly appreciated the NZ Herald giving us the opportunity to respond.
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