The road to the ubiquitification™ of responsible investing has been a long one – hundreds of years long. But environmental, social and governance (ESG) investing is really a 21st Century phenomenon, the rapid rise of which builds on the much older socially responsible investment (SRI) movement. Impact is the inevitable final frontier.
But first, some context.
The term ESG was coined in 2005. In 2006, the United Nations launched the six Principles for Responsible Investment: “a voluntary and aspirational set of investment principles that offer a menu of possible actions for incorporating ESG issues into investment practice." [1] The goal was a more sustainable global financial system.
It couldn’t have come too soon. The Global Financial Crisis (GFC) of 2008 almost decimated the financial industry, as well as the societies in which it operates. It was a painful reminder of the delicate balance between economies, stakeholders and markets. Investors and regulators emerged chastened, with a renewed focus on the significance of long-term stewardship and good corporate governance.
Today, the PRI is a network of over 1,700 international investors representing over $70 trillion.ESG investing is estimated at over $30 trillion in AUM, or almost half of the world’s professionally managed assets. A proliferation of national ESG mandates and disclosure regulations, such as the European Commission’s sustainability disclosure rules, have propelled ESG the mainstream.
Investors were initially reluctant to embrace ESG, arguing their fiduciary responsibility was limited to maximising shareholder value regardless of environmental or social impact or governance concerns. But ESG has since been accepted as a litmus test for company sustainability and so become a key part of financial analysis and fiduciary responsibility.
Fast-forward a decade, and ESG is simply good investing. The problem is, it’s not good enough.
If corporate governance was a bandage for the problems caused by the GFC, impact investing addresses the suite of global issues now reaching a critical point. From climate change to resource scarcity, the social and environmental threats we face today can no longer be ignored. Nor can they be rectified via good corporate behaviour alone. Realistically, the world is unlikely to reach the Paris Agreement targets or bridge the $5-7 trillion funding gap needed to meet the UN Sustainable Development Goals without a significant shift in capital allocation.
It’s also the sensible thing to do. In the 20th Century, we woke up to the fact that our business has an impact on society and the environment. More recently, we’ve learned that society and the environment have an impact on our business. CPD estimates climate risk will cost the world’s biggest companies $1 trillion, with most of that value lost in the next five years; [3] other predictions put annual output losses at 1% to 5% depending on how much action is taken and when. [4]
But impact investing isn’t just urgent and necessary; it’s also hugely exciting.
The shift to a new economy – one where progress doesn’t hinge on resource waste and environmental decline, but instead on new technologies – is arguably one of the greatest investment opportunities since the Industrial Revolution. As corporations move away from quarterly results, what is good for people and planet will coalesce with what’s good for bottom-line returns.
All this may sound like a panacea for investors seeking to align their investments with their values and find a new point of differentiation. Unfortunately, however, the industry still hasn’t cracked impact.
The obstacle is non-financial data. How do you gather it? Measure it? Standardise it?
Measuring financial risk and reward is easy by comparison. It’s not hard, after all, to determine whether or not you made a financial return on an investment; it’s much more difficult to assess its social or environmental return. As with financial returns, non-financial returns can increase or decrease as a result of myriad external factors, be it the stage of the economic cycle, industry disruption or new regulation. But unlike financial returns, which can be measured by a single metric – money – non-financial returns can manifest in almost countless ways.
But when we finally reach consensus on what non-financial returns look like, as well as how to generate them in a way that is automated, scalable and cost-efficient, this niche and nascent sector will make an indelible mark on the financial system.
To paraphrase Adam Tooze: a decade after the world bailed out finance, it’s time for finance to bail out the world.
[1] UNPRI
[2] GlobalSustainable Investment Alliance, 2018 Review
[3] CarbonDisclosure Project, 2018 annual report
[4] KPMG
