{"id":8601,"date":"2022-10-06T19:16:15","date_gmt":"2022-10-06T17:16:15","guid":{"rendered":"https:\/\/escp.eu\/thechoice\/?p=8601"},"modified":"2023-02-17T16:49:40","modified_gmt":"2023-02-17T14:49:40","slug":"how-todays-investment-portfolios-are-impacted-by-esg-policy","status":"publish","type":"post","link":"https:\/\/escp.eu\/thechoice\/tomorrow-choices\/how-todays-investment-portfolios-are-impacted-by-esg-policy\/","title":{"rendered":"How today’s investment portfolios are impacted by ESG policy, market and portfolio construction"},"content":{"rendered":"\n

With the intention to share their research with a wider public, from students to experienced professionals, Kartik Chawla, Martina Macpherson and Daniel Ung explore the impact of sustainable investment approaches on investment decision-making, with a focus on the analysis of controversies at corporate and sovereign levels, and discuss potential performance implications and trade-offs. The insights come from the chapter \u201cAnalysing ESG policy, market and portfolio construction considerations in investment portfolios\u201d in the newly published ESG Investing and Analysis: A Practitioner\u2019s Guide (RiskBooks, 2022).<\/em><\/p>\n\n\n\n

Over the last two decades, investors have increasingly considered environmental, social and governance (ESG) criteria within their investment decisions to meet their varying expectations, such as using ESG as an expression of personal ethics and values, as a means of downside risk protection in the investment portfolio, or as a new source of investment alpha. New regulations, such as the European Union Sustainable Finance Disclosure Regulation<\/a>, have mandated that investment managers classify and disclose their sustainability risks.<\/p>\n\n\n\n

According to the Global Sustainable Investment Alliance (GSIA),<\/a> the size of the sustainable investment market is approximately US$35.3 trillion. It is estimated to reach US$53 trillion by 2025 (Bloomberg Intelligence, 2021). Much of the growth has emanated from North America and Europe. Alongside the growing interest in ESG, a vast array of ESG regulations have been initiated around the world. The Principles for Responsible Investment<\/a> reports that there are now more than 750 policy tools and guidance frameworks globally, including 159 new or revised ESG policy instruments.<\/p>\n\n\n\n

Incorporating the ESG \u2013 the extra-financial insights in investment analysis are still novel to many investors and can be challenging because of the often-conflicting opinions provided by ESG providers and differences in government policies and ambitions.<\/strong><\/p>\n\n\n\n

What you should know when considering sustainable investments<\/h2>\n\n\n\n

When it comes to investment portfolio construction, one size does not fit all, and sustainable investing is ultimately an all-inclusive category encompassing a broad range of strategies. There are traditional \u201cfinance-first\u201d strategies that focus mainly on maximising shareholder value, absolute or risk-adjusted returns, and centring around the efficiency of capital markets. Meanwhile, strategies such as philanthropy and social impact investing aim to enhance the welfare of segments of society, particularly in relation to human and worker rights, gender equality and climate change, among other social considerations.<\/p>\n\n\n

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The spectrum of financial and extra-financial investment strategies. Source: Boffo and Patalano, 2020<\/em><\/figcaption><\/figure><\/div>\n\n\n

What drives the growth of sustainable investing?<\/h4>\n\n\n\n

The tremendous growth in sustainable investing can be attributed to a change in investor mindset through an increase in awareness of social issues, evolving expectations and a changing regulatory landscape. Another reason for the impressive growth in ESG investments is increasing demand from retail investors.<\/p>\n\n\n\n

Meanwhile, policy tools globally are aimed at promoting not only ESG investments but also the data quality of ESG ratings against which many investments are measured. The regulatory scrutiny in relation to ESG data quality and rating methodologies has gathered pace, especially since the publication of the International Organization of Securities Commissions (IOSCO) report on \u201cESG Ratings and Data Products Providers\u201d<\/a>. This development contributed to the announcement by the European Securities and Markets Authority (ESMA)<\/a> that aims to tackle greenwashing and promote transparency in ESG and credit ratings. There is also a growing push by regulatory authorities to develop \u201cuniversal\u201d ESG reporting and disclosure standards for both corporates and investors.<\/p>\n\n\n\n

Types of sustainable investment strategies available<\/h4>\n\n\n\n

The Global Sustainable Investment Alliance<\/a> has highlighted seven main ESG approaches for sustainable investing into which most sustainable investment funds fit. These are: ESG integration; negative screening; norms-based screening; positive and best-in-class screening; corporate engagement and shareholder action; sustainable-themed investing; and impact and community investing.<\/p>\n\n\n

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Assets Under Management grouped by the type of ESG investment strategy. Source: GSIA, 2020<\/figcaption><\/figure><\/div>\n\n\n

The ESG considerations are also increasingly being accounted for in non-listed assets<\/strong>, such as infrastructure, real estate and private equity, and debt. A prime motivation for this is that investors aim to align their investments with their ESG values and beliefs to minimise reputational risks and satisfy external stakeholder requirements, according to BNP\u2019s ESG global survey<\/a>.<\/a><\/p>\n\n\n\n

Portfolio impact of ESG investing<\/h4>\n\n\n\n

Many studies, such as Harvard Business School, found \u201ca positive correlation between sustainability and superior market performance\u201d.<\/strong><\/a><\/p>\n\n\n\n

The focus of many studies has traditionally been on the quality and management of corporate governance (G) and how this \u201cfactor\u201d can positively or negatively influence stock price performance. In line with the surge in interest in climate change mitigation and adaptation, circular economy and biodiversity issues, research has also documented a direct link between the environmental (E) performance of firms and stock price performance.<\/p>\n\n\n\n

ESG controversies and their impact on stock price performance<\/h4>\n\n\n\n

Questionable business practices and unethical corporate behaviours are commonly considered in the evaluations used for constructing ESG ratings. However, investors can equally just focus on the ESG controversies of a particular company or sovereign. This makes sense from a portfolio performance perspective, as academic and industry research outlines that unethical and controversial business areas and practices, involving a range of material ESG issues, can have a material impact on corporates\u2019 cost of capital as well as their share price performance. This impact can hence mean a material loss of financial value.<\/p>\n\n\n\n

According to research by Bank of America<\/a>, 22 controversies have wiped more than US$500 billion off the value of large US stock\/listed companies since the mid to late 2010s. The research examines the impact on stock prices of companies in the S&P 500 index implicated in 24 types of controversies related to accounting scandals, data breaches, sexual harassment cases and other ESG issues. It found these companies together experienced peak-to-trough market value losses of US$534 billion as their share prices sank relative to the S&P 500 over the 12 months after the controversies were uncovered.<\/p>\n\n\n\n

Key findings from various similar research undertaken:<\/strong><\/p>\n\n\n\n