ESG Research: Underlying Risks and Opportunities

Considering environmental, social, and corporate governance (ESG) criteria during investment assessment and valuation is regarded as responsible investing. ESG research and evaluation has been proven to generate long-term financial returns and drive positive impact for government, private and corporate entities. 

Business stakeholders, especially asset owners, have been increasingly focusing on how asset managers such as private equity firms are assessing ESG risk. These assessments inform acquisition and buyout decisions and subsequently help manage risk to safeguard value and open up opportunities for value generation. 

Some of the primary focus areas of ESG criteria are

• Climate change – adaptation and mitigation 
• Climate change impact
• Environmental management and duty of care
• Safety in working conditions
• Respect for human rights
• Anti-corruption and anti-bribery practices
• Relevant laws and regulatory compliance

Responsible investment means considering the impact of growing concerns such as climate change and emerging voluntary guidelines or regulations, such as the UK Modern Slavery Act. It also includes wider requirements related to transparency for stakeholders.

ESG integration

ESG integration refers to the implementation of ESG strategies. Investors can use ESG research to evaluate the integration of ESG factors across their investment process. These strategies cover a wide range of enterprise objectives and goals, including

• Mitigating long-term systemic risks, such as carbon emission and any other environment-related risk. Asset owners specifically may be concerned that the potential effects of a spillover from direct investments could generate costs for various third parties. This will consequently affect their future returns and the economy in general
• Reducing systemic risks that result from changes in the global economy and market environment
• Identifying stock-specific portfolio opportunities and risks

In the past few years, ESG investing and criteria have gained significant attention because of three specific factors:

1. Recent academic and industry studies have suggested that under specific conditions, ESG investing improves risk management and results in returns that are no less than traditional financial investments in any way. Despite recent studies, investors are becoming more aware of the complexities that arise when ESG performances are measured
2. Societies and economies, in general, are paying more attention to the risks of climate change. They are also more aware of the benefits of responsible business conduct and the global standards governing them, as well as the importance of diversity on decision-making boards and in the workplace. All of this reflects societal values that are increasingly influencing consumer and investor choices and could increasingly affect corporate performance
3. Financial institutions and corporations have been stepping away from short-term plans for returns and risks. The aim is to reflect more long-term sustainability in terms of marketing performance. A growing number of investors have also been looking to enhance long-term returns sustainability, while others aim at incorporating a more formal alignment with relevant societal values. In both cases, evidence is increasing that financial sustainability needs to incorporate more diverse external factors for higher profits and maximised returns in the long run. At the same time, this also reduces the probability of controversies that could erode customer loyalty and stakeholder trust

Given the steady rise in demand, the finance domain has been coming up with more offerings related to ESG indices, funds and ratings. Companies that call themselves ESG rating providers have grown multi-fold. There are several hundred ESG indices, fixed and equity income funds and ETFs, with the number increasing each day. Any investor today can engage in ESG investing using low-risk investment products (example, money market funds) and passive smart beta ETFs. They can also take a position using a hedge fund, combining sophisticated strategies with ESG investing. 

Investors who are looking to prepare themselves for a transition to low-carbon economies have the option of investing in renewables and green transition funds. In this regard, financial markets have proven themselves agile, as they respond to demand from investors in a customer-oriented and transparent manner. 

Despite this progress, the growing use of ESG ratings, disclosures and ESG-related funds has resulted in a deeper checking of them all by marketing practitioners. There has also been an increase in awareness within the industry that ESG investing practices should evolve to meet user expectations and sustain user trust. 

Conclusion

Businesses today need a reliable ESG research partner to help build databases, develop frameworks and much more. This will help them maintain a competitive edge and remain ahead in today’s increasingly competitive market.