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Why sustainable investing and ESG performance monitoring are critical for investors

by maria gbaf

By Hitanshu Dhingra, AVP Investment at iResearch Services

A laser focus on getting the best rates of return is no longer enough for a new breed of investors, ever mindful of the ethical credentials of the companies they deal with and the broader impact that their actions have.

BlackRock, the world’s largest investment fund, nailed its colours to the mast in March 2020, declaring it would no longer include companies active in areas it considers having negative societal impact, such as fossil fuels, in its portfolio. Others are following suit; evaluating a company’s environmental, social and governance ratings (ESG) alongside traditional financial metrics to drive socially responsible investment decisions.

For some, the decision to invest at all must be justified by altruistic pay off, while others will assess the ethical credentials of organisations based on the criteria and opportunities that offer positive environmental and social outcomes, and avoid the risk associated with poor ESG practices.

The pandemic’s impact on investment strategies

While this traction has been percolating for a while, it was always going to take a seismic change to see a meaningful shift away from the traditional pressure to chase profit and line shareholders’ pockets. The momentum consolidated by the Covid-19 pandemic and the more socially, community spirited zeitgeist it generated has proven to be a gamechanger, compounded by the high-profile climate change narrative and demand for greater corporate transparency and stakeholder accountability. As all these factors conspire, attention falls more acutely on how companies treat both their stakeholders – particularly employees and their customers – as well as the environment. These factors increasingly define their reputation within the broader business community and public and can have a marked bearing on their market share.

We know from high profile examples that in a more accountable climate, social responsibility fails can catch out a big name and do lasting damage.  The scandal that engulfed Volkswagen is a case in point, when the German car maker admitted to using software that manipulated the engine performance, so the manufactured cars passed U.S. diesel admissions tests.  While the social irresponsibility was clear cut and widely condemned, the affair also highlighted some of the grey areas that arise when dealing with the consequences. While Volkswagen admitted to a breach of corporate policy, the fact that the policies were defined in non-legally binding terms such as ‘ethical principles’ and ‘voluntary commitments’ underlines a broader need for less ambiguity in how companies define their actions and decisions, and more broadly, the need for more standardised reporting in this area.

Transparency is crucial for the future of sustainable investing

From our own research into sustainability within the financial services industry specifically, we found that more than half of organisations felt their competitors were conducting greenwashing activity to mislead environmental practices. This demonstrates the issue occurring within industries, but also the mindset that many businesses can operate deceptively to gain public and investor trust, and create a false perception, which we must do more to prevent. In contrast, however, we found from this study that only 18% of business leaders didn’t see the value in becoming sustainable. Clearly, investors and business leaders are aligned on sustainable initiatives being the route forward.

The momentum behind sustainable investment is being driven by investors. While there is an expectation for the company to be doing the right thing anyway rather than simply paying lip service to the corporate social responsibility agenda, being able to demonstrate compliance and good practice with detailed and accessible data is critical. Otherwise, efforts can slip the net when an investor is assessing performance and making comparisons.

While, in so many other spheres, further regulations and red tape are universally unwelcome, seen as stifling and adding excessive complexity, in the financial sector, there is appetite for more guidance and transparency to provide a clear picture beyond what a company chooses to report and to help distinguish between what is greenwashing and the real deal.

Do we need regulation to set standards in sustainability?

Ensuring consistency, comparability, and quality of core metrics in reporting frameworks for ESG disclosures, therefore, becomes a priority, though considerable shortcomings prevail that can undermine its usefulness to investors. Businesses that I am speaking to want and require a standard to be set for how they must measure and report on sustainable initiatives, because transparency is critical for investors to be well-informed.

The European Union’s (EU) Sustainable Finance Disclosure Regulation (SFDR), which came into force in March 2021, represents a significant move to boost reporting and transparency, but a stronger policy framework will need to combine with the right evaluating tools in the form of the frictionless fintech to drive more integrated and seamless ethical investment behaviours.

The ability to access dashboards that give data-driven insight on new carbon footprint measurement, assets, and resource optimisation is critical. Those that display statistics as graphics to provide an instant snapshot of the performance and opportunities that could otherwise be buried in spreadsheets will reveal how every pound/dollar spent is impacting on the environment and working towards social good – critical knowledge for both the company and the investor.

The sustainable investing movement has been driving many innovations such as electric vehicles (EVs), green hydrogen, aquaculture, and we are just scratching the surface. It will still take time to make these alternatives commercially competitive, but we believe that they will disrupt traditional business models completely. There are still many unexplored opportunities in each sustainable business theme, and we expect to see continued flow in funds into sustainable investments.

In conclusion, while there are some gaps in trust and perception, the outlook remains positive for sustainable investment. Stronger regulation and directives to provide a standard form of measurement and disclosure are critical, which is an agenda driven by the investment community. Investors are driving sustainable operations forward and it is not a short-term money grab, but a clear demand on business leaders to make sure that commitments are being kept and actions delivered.

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