From The Straits Times    |

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What are ESG investments, and why is this acronym trending at the moment? In this two-part series on ESG investments, we deep dive into this hot topic among investors right now. To read part one where we explore the impact of social and governance factors in ESG investing, click here.

Whether your investment portfolio consists of equities or bonds, you would have probably started out on your investment journey with one clear mandate: Make your money work for you. But there’s been an added dimension to this equation: What impact does the company you’re investing in have on people and the planet?

This has become especially apparent in the corporate world, where ESG (Environment, Social and Governance)-linked investments have been gaining momentum. These include stocks, bonds, exchange traded funds (ETFs), mutual funds, and managed portfolios.

Samantha Horton, chief business officer of investment platform Syfe, notes that since the company launched the ESG and Clean Energy thematic portfolio in 2021, it has seen a growing interest from investors.

She says: “In 2021, Syfe introduced a suite of thematic portfolios designed for investors to tap into the opportunities presented by megatrends or long-term structural shifts. To date, the total number of ‘ESG and Clean Energy’ portfolios forms over 40 per cent of the total portfolios created across Syfe’s five thematic portfolios. In fact, it is almost double our next popular theme of disruptive technology. This shows the significant demand and growth for sustainability-related investments. ‘ESG and Clean Energy’ is also the most popular theme for women, with 42 per cent of women who invest in thematic portfolios selecting our ESG portfolio.”

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Previously, we examined the social and governance aspects of the ESG equation in the first of this two-part series, and explained how investors such as you and I can vote with our wallets to influence how companies are building equitable, diverse and inclusive ecosystems.

Here in the second part (you can read the first part here), we explore how ESG investing can help the environment.

How does ESG investing drive sustainability and climate change curbs?

ESG essentially nudges companies to do better when it comes to reducing their environmental footprint.

So by the same token, ESG investing means that retail investors take into consideration “the impact of investment on the environment and society at large”, says Endowus’ Min.

“Broadly speaking, it looks at how companies treat the environment and key stakeholders from different parts of society. Subsequently, ESG investing avoids irresponsible companies and prefers companies that are responsible corporate citizens.”

A company that puts the planet at the centre of its sustainability efforts could do so in a myriad ways, including offsetting its carbon emissions by embarking on a netzero plan, protecting the biodiversity in the environments it operates in, reducing water pollution and waste, or switching its energy supply from fossil fuels to natural sources.

You can invest in/purchase ESG-linked products including stocks, bonds, ETFs, mutual funds, and managed portfolios.

ESG investing avoids irresponsible companies and prefers companies that are responsible corporate citizens. Credit: Getty Images

Maria Jelen, regional head of relationship management and sales trading for Asia Pacific at investment platform Saxo, adds: “Environmental factors are associated with a company’s impact on the environment (ie carbon footprint, greenhouse gas emissions), use and preservation of resources, waste management, pollution, as well as innovation efforts for the design of more sustainable products.”

Syfe’s Samantha adds: “ESG investing has gained significant ground because it is directly related to a spectrum of business critical issues such as the environment, water management, health and safety, board accountability and executive pay – these are issues that can directly affect not only a company’s reputation, but also its performance and stock valuation. It is clear that more people are putting their money where they can align their investments with the opportunity of driving positive outcomes in the world around them.”

She suggests “choosing efficient methods to invest in a diversified manner”, adding that Syfe uses “ETFs as the building blocks of our portfolios. ETFs are cost-efficient, and we select those with the lowest tracking errors and decent AUM (assets under management) size.”

What is negative screening?

There are several strategies when it comes to ESG investing but the most popular, according to Maria, are negative screening, followed by ESG integration.

“Negative screening aims to exclude companies or sectors that don’t align with an investor’s principles, while ESG integration is about incorporating material ESG factors as part of traditional fundamental analysis,” she says.

Negative screening would mean that you exclude oil and gas companies from your portfolio, for example. ESG integration, on the other hand, implies that you would go the extra mile to determine whether the company you’re eyeing is ESG-compliant, and base your decision on the company’s ESG rating.

79% of millennials surveyed indicated their interest in environmental issues, according to a 2019 OCBC Bank survey.

How are companies rated?

ESG ratings are how companies are evaluated with regards to how they’re performing in terms of environmental, social and governance issues.

There’s an issue here though: There is no single regulating body that sets the guidelines for the rankings. You can look at the companies that are on the S&P 500 ESG Index, or you can check the ratings from credible sources like MSCI or Sustainalytics. However, each of these organisations has its own set of guidelines and systems.

Says Saxo’s Maria: “There is no standard definition for what determines an ESG compliant investment, but generally, a company that manages its environmental, social and governance risks, and seeks to benefit all stakeholders, not just the shareholders, could be considered an ESG friendly company.”

ESG ratings providers typically source from various data points and formulae to calculate their ESG scores. Some agencies might use numerical scores, while others use letter rankings, which makes it difficult to make comparisons.

Can I rely on the rating for credibility?

At its core, ESG is incredibly hard to measure. For one, it encompasses three massive areas of concern that each has its own nuances and complexities. A company that has great opportunities for all genders and races might be a massive polluter, for example.

80% of Singapore investors surveyed by HSBC in 2021 say they believe in ESG investing…but only a quarter are actually making ESG investments.

The Business Times

Some companies might also be offsetting their carbon emissions by buying carbon credits, while others might be taking tangible steps to protect the biodiverse environment they operate in.

For many organisations, starting a corporate sustainability programme is sometimes where they begin and end their journey. It takes a consistent, consolidated approach, one that can take years to come to fruition. Going carbon-neutral is a long-term journey that cannot happen overnight. They would have to build a roadmap and measure their success with milestones, and build a system of accountability to report their progress.

One of the most common metrics include evaluating a company’s scope 1, 2, and 3 emissions:

● Scope 1 and 2 implies the company’s direct emissions – this could be from the equipment it owns, for instance, or waste generated from its daily operations.

● Scope 3 are indirect emissions that occur further along the supply chain. Think emissions from transportation and distribution, or business travel.

In July 2022, the Monetary Authority of Singapore (MAS) announced that it is drawing up a set of disclosure and reporting guidelines for ESG-linked funds. It has also launched a slew of other digital initiatives to encourage greater transparency.

MAS’ measures to encourage greater transparency are encouraging, because this means that there is a lesser likelihood of greenwashing.

Investors should generally be wary of broad ESG statements that are not substantiated in the company’s narrative of supported by facts. Credit: Getty Images

Ah, here’s the G word – how prevalent is greenwashing?

There have been countless reports from research groups detailing how companies have failed to meet their ESG promises.

Research by Influencemap in 2021 says that out of 130 climate-themed funds, 55 per cent received negative Paris Agreement Alignment scores; meanwhile, a 2019 study by 2 Degrees Investing Initiative found that 85 per cent of environmentally linked funds had been accused of misleading investors.

Saxo’s Maria explains: “Greenwashing happens when companies or fund managers make misleading ESG claims about their companies, products or services. It’s not going to disappear overnight, but a number of regulators around the world are coming up with new rules and regulations to combat greenwashing.

“Other ways to not fall prey to greenwashing include, understanding what ESG is, reviewing companies’ ESG statements, fund’s prospectus, and checking third party providers ESG ratings of companies and funds.”

Maria adds: “Greenwashing is generally subtle, so it’s difficult to pinpoint common greenwashing claims. Investors should generally be wary of broad ESG statements that are not substantiated in the company’s narrative or supported by facts.”

Besides the fact that ESG factors are determined differently by different agencies, we also need to understand that environmental sustainability is a relatively new topic that many companies are not equipped to deal with, and they might be at varying stages of their progress.

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Where would I even start?

We’ll be honest: Investing in ESG-linked products is not as straightforward as choosing to invest in a blue chip company. If you want to really make sure that your money goes a long way, you need to be prepared to do plenty of research – besides consulting a trusted wealth or portfolio manager, of course.

Endowus’ Min says: “Investors can identify sustainable and ESG-focused funds by checking for public disclosures, such as under the Sustainable Finance Disclosure Regulation (SFDR), or the Fund Manager’s voluntary sustainability reporting.” SFDR is a European regulatory body that enforces regulations on companies to disclose their ESG considerations in order to increase transparency.

Syfe’s Samantha adds: “Investors who are interested in a deeper dive can look to the Bloomberg ESG data, MSCI ESG, Sustainalytics, Thomson Reuters ESG Research Data, all of which have different ESG metrics, depending on the report provider and the rating scales.”

You could also follow the company closely on social media, read its annual reports, and keep up with its latest announcements, in order to keep track of the actions undertaken to reduce its footprint.