Is ESG investing just a passing fad?
Planet Earth II,
Life etc On IMDB, these tend to be rated 9+ out of 10, which is exceptionally rare and good. The common theme is not only that they each speak of the beautiful planet we call home, but also that the narrator is Sir David Attenborough. This gentleman, whom you probably already know, is 95 years old. Even at his age, you might not find a more passionate and energetic person for saving the environment.
In 2020, he featured heavily in an eponymous subtitled documentary
A life on our planet. Some of the visuals he exhibits, of himself having visited parts of the world from more than half a century ago to today, are shocking. Significant forest cover has disappeared, as have countless species of animals, plants and insects that lived there.
Some particularly mind-boggling statistics he mentions: 1) Human beings cut down over 15 billion trees every year. Since the beginning, we have cut down 3 trillion trees in total. It is 50% of all the trees on the planet. 2) 90% of all large fish in the sea have disappeared due to overfishing. As a result, a significant part of the marine ecosystem died. This has impacted the ocean’s ability to absorb carbon dioxide, leading to warmer climates and erratic seasons. 3) During the last ice age, when global temperatures were only 4-7 degrees lower than today, the city of Chicago was under 800 meters of ice (like a mountain of ice). With rapid industrialization, we are now running in the opposite direction – on track to become 3-4 degrees warmer than baseline, and already about 1 degree warmer than ideal. Every half-degree increase now could be devastating. Is this what we want to be? Is this the legacy we want to leave for the future?
In the investment world, ESG has become a buzzword. What is that? ESG stands for Environment, Social & Governance. This means prioritizing investments in companies that treat the environment well or at least do not harm it (such as through climate change, effluents, carbon emissions), that treat their employees and their stakeholders well ( social, diversity and inclusion), and are not involved in fraud and scams (governance).
ESG has put many supporters and opponents at loggerheads. Is ESG real or just a fad? It depends on the objective. From an environmental perspective, for example, if you really care about saving the planet, then ESG is a powerful tool in the hands of such a rescuer. Leading valuation expert Professor Ashwath Damodaran singled out ESG in his blog last year. He made several arguments – that ESG adopters were doing it for their own benefit (i.e. to sell more products), that there is little data and correlation between ESG and returns, and that value systems differ between people and others. These are valid of course, but the answer may not be to completely ignore ESG either.
So how do investors integrate ESG into their investments? For some investors, while “G” has always been important, the “E” and “S” factors are also beginning to gain in importance. It is preferable to apply these layers for all investments, rather than for specific ESG labeled funds. Working with external consultants and experts to deepen your understanding of ESG trends can also be helpful. Even so, it is not an easy path. Doing the “right thing” could mean giving up short-term investment returns instead of ESG improvements. Is it an easy call? Absolutely not.
However, as fundamental investors, one would expect that over the long term, there is an outperformance bias towards companies that perform well on ESG factors. Note that this is not as simple as supporting companies with high ESG scores. Because on the one hand, the scores vary a lot from one data provider to another. And second, many companies in India do not disclose enough data about their environment or their social footprint. In fact, in our experience, simply providing better information can lead to upgrades in ESG ratings.
Some practitioners also completely avoid certain areas. Defense is an example. A company that manufactures explosives for use by civilians is certainly not acceptable. But what about the one who creates defense systems to protect the borders of his country? You can now appreciate how several gray areas exist. But this is also where many opportunities lie. Instead of simply ‘excluding’ sectors and companies due to poor scores, it would be important to engage with them and guide them to better insights and practices. Is everything still perfect? Far from there. There is a lot to learn, but moving forward is imperative – in a space that is itself changing very rapidly.
In his book
How to avoid a climate catastrophe, Bill Gates says there are only two numbers we should be concerned about. 51 billion, and zero. What is that? 51 billion tons is the amount of greenhouse gases we emit into the Earth’s atmosphere every year. And zero is the number that it must reach. While no one person or entity is enough to effect this type of change, if we each do our part, then collectively we can succeed. It’s still not too late to contribute. But we can’t delay any longer. Sir David Attenborough reserves the last word here: “It’s not about saving our planet. It’s about saving us. »
(The author, Mahesh Ramasubramanian, is vice president and investment strategist, DSP Investment Managers. Opinions are his own)