KUALA LUMPUR (Aug 19): Investing is no longer just a game of evaluating companies' profits and estimating how much they are worth. It has become about how the business is run, how it relates to the natural environment and how it treats the people it employs.
Such investing trends are influenced by the growing acceptance of climate change goals because we now think a lot more about sustainability of the environment for our future generations. By investing in companies that find solutions to the environmental crisis, investors can help build a better world for future generations.
One such example is where tons of plastics are dumped into the sea daily and some fishermen are now catching more plastic than fish. While many of us have been trying to reduce plastic usage on a daily basis — by packing our meals using tiffin containers, using recyclable bags during grocery shopping and swapping out plastic straws — we can now go beyond that by investing in companies that produce technologically advanced alternatives to plastic that could change things altogether.
This is what sustainable investing is about. This is also known as socially responsible investing with the aim of achieving a better and more sustainable future for society as a whole.
Sustainable investing requires consideration of environmental, social and governance (ESG) factors in the investment process, also referred to as ESG investing. Broadly, the practice of sustainable investing today can be categorised into three main strategies. First, selectively leaving out companies or industries, that is, coming up with an "exclusion" or "negative" list. Common examples are weapons, tobacco, fossil fuels and gambling.
Second, the integration of financially relevant ESG factors into investment decisions. An example would be incorporating the risk of future taxes or legal costs when assessing the future profitability of businesses that use aggressive tax-avoidance strategies or have poor labour policies.
The third would be impact investing, where investors explicitly aim to achieve positive ESG outcomes via their investment decisions — directing capital to companies with the right mission or products and services. Examples include companies fighting climate change; alleviating poverty; eliminating gender or racial discrimination; and improving access to clean water, healthcare and education for disadvantaged groups. In this area, the UN leads with its Sustainable Development Goals (17 SDGs in total), which are designed to guide impact investing strategies.
Many investors now put sustainable investing front and centre of their investment process, incorporating ESG factors when deciding where their money should go and engaging more directly with impact investing aimed at achieving one or more of the SDGs. As more resources are directed to areas of sustainable investing, there is a small but growing body of evidence that shows that ESG factors can be integrated successfully into the investment process without sacrificing returns.
Overall, companies with better ESG profiles — including better environmental standards and employee relations, and a higher proportion of institutional ownership and outside directors — are able to borrow more cheaply, have higher credit rankings and lower cost of equity capital, according to a 2018 review of academic research by NYU Stern School of Business and quantitative investment firm QMA. They are also worth more.
Businesses across most sectors of the economy face significant disruptions to their existing operations as the world moves to decarbonise. Some of these disruptions are likely to take place rapidly as new climate policies intersect with new technology to propel low carbon alternatives to the forefront across a wide range of economic activity, triggering rapid shifts in consumer behaviour.
Last year, worldwide spending on renewable energy, electrification of heating and transport, and other energy transition initiatives reached a record US$501 billion despite the severe disruption from Covid-19. We expect this to grow even more over the next few years as nations strive to reduce the amount of carbon they release into the environment by increasing the use of environmentally friendly practices and technologies. Examples include green energy and electric vehicle production.
While the goal of net zero carbon emissions will disrupt many industries, the transition to a climate-friendly global economy is set to drive innovation and economic growth and create new opportunities for businesses. Companies that reduce emissions and waste, reuse natural resources and deliver products and services that support the overall decarbonisation of human activity are likely to attract a greater amount of capital.
Therefore, for investors looking for returns, it is time to include sustainable investing as part of the key consideration in managing their portfolios.
Michael Lai is Executive Director of Wealth Advisory at OCBC Bank (Malaysia) Berhad