By Dale Critchley, Policy Manager, Aviva
ESG (environmental, social, governance) investing is a term many people are becoming more aware of. Essentially it means scrutinising a wider range of factors about the companies in which savings are being invested, to ensure that risks to long term investment are fully understood.
An investment manager will look at factors like a company’s record on environmental practices, how they treat their employees and whether they have strong internal controls. The idea is that companies that perform better in these areas are likely to generate better long-term returns.
ESG doesn’t mean that pension funds will automatically disinvest from companies that have a poor outlook when measured against ESG criteria. But it does flag up the need to talk to those companies and use shareholder voting rights to influence their decisions, to reduce those long-term risks. Aviva Investors, for instance, worked with fashion brand Burberry to get them to reduce the amount of fur they use in their clothing. As well as being the right thing to do, in many peoples’ minds, this reduced the risk that consumers might avoid the brand, which would in turn have hit the share price.
ESG investing doesn’t have to come at the cost of lower returns. Back in the day, investing in a green fund may have meant investing in companies trialling new methods of doing things. This was often a risky and possibly unprofitable business, but things have changed. Screening investments based on a wider range of factors, including ESG issues, means fund managers invest in companies with high standards in all areas. Morgan Stanley recently published research on the performance of nearly 11,000 mutual funds from 2004-2018 which shows there is not a financial trade-off in the returns on sustainable funds to traditional funds, and they demonstrate lower downside risk. But this doesn’t just mean companies building electric cars or making beeswax wrapping paper. It’s about investing in companies with a good social and environmental practices, across a wide range of sectors.
It’s the fundamental difference between taking ESG risks into account and investing according to a narrow set of parameters that exclude “bad” companies. While the latter risks concentrating investments and increasing risk, the former allows a wider choice of sectors to invest in. This can spread the risk, but also increase the positive impact on the environment or wider society. By exerting a positive influence on a wider range of companies a stewardship approach can lead to better returns, and turn a “bad” company’s ESG strategy around.
While ESG investing has been around for some time, workplace pensions have made it more visible. 10 million new auto-enrolment savers are beginning to pay attention to where their savings are going.
A minority are realising they can make their own investment decisions and invest in line with their own personal values, but by far the greatest number remain in default investments. These defaults have been limited in the extent they can address socially responsible investments by the charge cap, but they’re now catching up, with many incorporating ESG values. This means that even if someone doesn’t want to make their own investment decisions, they can be reassured that their money is being used in a responsible way.
With the number of people saving into a workplace pension only getting larger, along with the increasing assets under management, it looks like ESG is here to stay.
i Law Commission, Pension Funds and Social Investment, June 2017 (paragraph 1.2)
ii https://www.morganstanley.com/pub/content/dam/msdotcom/ideas/sustainable-investing-offers-financial-performance-lowered-risk/Sustainable_Reality_Analyzing_Risk_and_Returns_of_Sustainable_Funds.pdf
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