For many, it feels like the acronyms are never ending when it comes to sustainability, impact, and other traditionally non-financial factors: ESG, D&I, CSR, SDGs, UNPRI, TCFD, SASB, GRI, SFDR, etc. So here's a brief Q&A with some of the simple questions on what many view as future of investing! Please note, these represent the opinions of Odyssey Capital and should not be considered financial advice.
What does ESG mean?
ESG is an acronym that stands for environmental, social, and governance. Environmental factors can include energy usage, impact on biodiversity, emissions, and other positive or negative impacts on the environment associated with an investment. Social factors can include community engagement, employee well-being, and workplace concerns. And Governance considers a variety of critical factors including management compensation, anti-corruption measures, regulation adherence, data security policies, and accountability frameworks.
What is ESG investing?
There are a lot of opinions on what ESG investing means - but in general, it can be simplified to be making investment decisions that integrate consideration of environmental, social, and governance factors alongside pure financial factors. In my opinion, this means that alignment, or lack thereof, on ESG factors is a material component of investment decisions, i.e. one will 'pass' on an investment with poor ESG alignment even if the financial metrics are favorable.
The variability in the industry around what is defined as ESG investing has led to classifications like "dark green" and "light green" or "ESG-lite." Regulation like the European Union's Sustainable Finance Disclosure Regulation ("SFDR"), which classifies sustainable investment products under Article 8 or 9, is designed to provide additional transparency on a firm's definition of ESG investing.
What is the difference between ESG investing and other "responsible" investing themes, like impact investing and socially responsible investing ("SRI")?
Depending on a firm's definition, there can be some overlap between these three. Generally, the variation is based on target financial returns and drivers of final capital decisions.
Impact Investing focuses on deploying capital into projects that target positive impact in addition to some financial return. Emphasis is on positive impacts on community or target population. Financial return targets can vary between market rate or sub-market rate, depending on the mandate.
Socially Responsible Investing focuses on deploying capital into or avoiding certain thematic areas. SRI has generally been associated with investors who have social or moral objections to certain industries, such as tobacco, alcohol, and weapon manufacturing. Often, SRI investing is based on negative screening parameters, which eliminate investment opportunities based on industry classification. Target returns can be market-rate or sub-market rate.
ESG Investing focuses on deploying capital based on an ESG evaluation framework and is generally seeking market-rate returns.
Are returns from ESG investing worse than traditional investing?
This is a myth that has been debunked by multiple studies. Given the varying definitions of ESG investing, there will fundamentally be variation in returns, but there is has been no evidence that returns are "worse." For further information on this topic, a few good places to start:
Why is there backlash against ESG?
While ESG has existed in some form within investing for some time, it has become quite popular in the last few years. Given how quickly information can be distributed, ESG has become somewhat of a marketing ploy by some who are interested in taking advantage of shifting markets without deeper integration. Furthermore, the popularity of the topic has led to actors outside of the finance industry utilizing ESG as a platform to push moral, political, or other personal opinions.
At Odyssey, it is our opinion that ESG factors are still and should remain fundamentally a tool for investment professionals to evaluate opportunities based on material data. We believe that ESG is not a political or partisan issue.
This is just a start of a few questions that come up frequently - what other questions are there on ESG and these spaces? Feel free to share any comments or feedback!