ESG Investing: Bridging the Gap Between Profit and Purpose
With the recent announcement of a new EIB green bond capitalization facility, investors have more opportunities to invest in sustainable projects. Moreover, it is expected that global green bond issuance will rise dramatically by the end of 2019, incentivizing institutional and corporate investors to allocate capital towards environmental projects and coming up with solutions for addressing climate change. Investing for profit versus investing for social or environmental benefits has become an important consideration for institutions, as well as individual and family investors. In many cases, these varying objectives can lead to conflicts within a company’s strategy. However, this does not mean that you should abandon your social or environmental objectives altogether — rather that you need to find the right balance between profit and purpose (ESG).
What is ESG investing?
ESG investing is a term for an investment portfolio that incorporates social, environmental and governance (S&E) characteristics. ESG strategies can be as simple as incorporating climate-positive practices in your business or as complex as developing zero-carbon emission initiatives.
ESG strategies are typically built around three components:
- Environmental impact: The direct impact of the investment, which includes considerations such as greenhouse gas emissions, energy efficiency, water use and waste disposal;
- Social investments: The indirect impact of the investment, including consideration of working conditions, employee benefits and community impact;
- Governance: The stakeholder relationships surrounding the company or asset being invested in, including consideration of human rights, corruption and political risk. Involving these three key factors will help to ensure you’re investing in a sustainable way.
Why ESG investing is important
ESG investing seeks to bridge the gap between profit and purpose. With ESG investing, companies can provide investors with a holistic view of the impact that they have in society. This allows them to make informed decisions about their investments. For example, your company could work with an independent third party to ensure you are performing well for both profit and social or environmental benefits. By partnering with an external party, your company can gain access to a second opinion on how these aspects of their business are performing. With this new perspective, it becomes easier for companies to prioritise the most important issues on their radar. For example, if a company’s mission is sustainability and they want to incorporate sustainable practices into the production of their products, they will be able to find someone who can help them assess how well those practices are working in practice. The combination of profit and purpose is a powerful way for investors and companies alike to create value for society at large as well as shareholders. In addition to providing increased value for shareholders by aligning ESG objectives with investment goals, ESG investing helps corporations become more sustainable by helping them make sure that they are meeting all of the company's goals across all operational areas; ESG makes it easier for organizations to design long-term strategy without losing sight of what matters most.
Conflicts between profit and purpose in investing
Although the growing popularity of ESG investing is increasingly making it more difficult to ignore the importance of a business’s social or environmental impact, conflicts between profit and purpose are still common. For example, how much profit should be generated in order to satisfy investors? Should there be a minimum threshold for ESG investments? What about allocating capital towards socially or environmentally responsible businesses that have a lower ROI than other companies? Such conflicts can be resolved by aligning your company’s objectives with your investors, as well as understanding their needs. An effective way to deal with these conflicts is by using performance metrics which provide an accurate view of your business’s success and can help you assess whether you are on track with your goals. For example, FTSE4Good aims to hold the top 500 publicly listed companies accountable for the quality of their ESG performance. It provides investors with a clear measure of a company’s ESG performance, such as how many times they were included in the index and how many times they were excluded from it. Similarly, you could benchmark yourself against other organizations in your sector which may have already implemented similar benchmarks. The key here is finding ways to answer questions like “how much profit should we make in order to satisfy our investors?” The answer will vary depending on what institutional investors require; some might want annual profits while others might want quarterly profits. It is important that you find out what type of investor is
How to identify ESG conflicts in your portfolio
Identifying ESG conflicts might be challenging but it is possible. For example, a company might land in a conflict when the company’s purpose is to reduce pollution and the company has operations in an extraction sector or where high-pressure hydraulic fracturing is used. ESG conflicts often exist between companies with similar values. For example, if a company invests in an environmentally friendly project that also involves low employee turnover and high quality of life for employees, these factors could easily clash with the profit motive. The challenge for investors is to identify ESG conflicts in their portfolios and take action by implementing strategies that can help to mitigate these conflicts. For example, a company could consider investing into more sustainable options like wind or solar power without compromising profit motives. They could also carefully select projects that align with both their values and profitability objectives while also considering current market opportunities and risk factors.
How to invest in ESGs for profit and purpose?
Investors are able to incorporate ESGs into investment strategies to align their business practices with the changing needs of society. To start, when managing your portfolio you need to consider how ESGs are integrated into your investment process. You should also assess the financial impact of taking on ESG-related risks, while looking at how they may affect the financial performance of your company. ESGs have a wide range of resources available for investors and it is important that companies focus on the particularities of their own industry when considering new possibilities for investment.
Bottom line
If your strategy is to make money and have an impact, then ESG matters. ESG investing has become a popular topic in recent years as many companies are starting to see it as beneficial for their bottom line. For example, a UK-based food company found that by including environmental metrics in its long-term strategy, it was able to avoid 70 million tonnes of carbon emissions and save $2 billion over 10 years. This is not just about having social or environmental goals. It’s about creating positive change in the world and making sure you are meeting your business objectives at the same time.