The trillion-dollar opportunity in ESG surge

The trillion-dollar opportunity in ESG surge 

Investors have been increasingly seeking out Environmental, Social and Governance (ESG) as a framework for investing in recent years, leading to a surge in ESG activity but one that is also coming up against backlash. 

A 2022 PwC report found ESG-focused institutional investment is “soaring” and will reach US$33.9 trillion in 2026, making up a whopping 21.5 per cent of assets under management. In the Asia-Pacific (APAC) region, PwC finds that assets under management will triple to reach US$3.3 trillion in 2026, outpacing a doubling of such activity in the US. 

And with younger investors leading the charge, the ESG surge is likely to continue. Eighty per cent of Gen Z/Millennials say their investment firm should influence the ESG policies or practices of the company even if it decreases the value of their investment, with the proportion dropping to 60% for Gen X and just 30% for Baby Boomers, according to a 2022 Stanford University study. 

ESG investing has also been shown to deliver, with CMC Markets finding that ESG funds/ETFs performed similarly to other major index ETFs in their respective countries between 2018 and 2021. During that same period, CMC Markets found that ESG funds/ETFs outperformed major indexes including the FTSE 100 and S&P 500. 

But ESG investing can carry challenges and complexities for even the most savvy of investors. 

Put simply, ESG investing involves selecting investments in ways that extend beyond mere company performance, including by its impact on the environment and communities, how the company is run and how it treats its employees. 

That’s a wide net, and as such identifying what falls under the ESG banner is far from straightforward, given the range of environmental, social and governance considerations that can come into play. 

Companies also see the opportunity in having ESG-like credentials, and are therefore putting considerable effort – and marketing dollars – into being more ESG-attractive than their record deserves. Also, while companies may perform well in or meet criteria in some areas – such as in having publicly outlined net zero commitments  – they may perform poorly elsewhere, such as addressing modern slavery in their supply chains. 

Meanwhile, the potential market for ESG investing looks set to expand further. Twenty nine per cent of women and 17 per cent of men have not heard of ESG, according to the 2023 ASX Investor Study. Currently, just 6 per cent of investors consider ESG a top priority – which with rising interest, education and publicity in the area, looks set to grow. 

The downside 

Assessing ESG performance is far from straightforward, given it means incorporating far less easily quantifiable non-financial factors in decision-making. 

Giving prominence to these non-financial factors can also be seen as increasing the risk profile of such investments. 

ESG investing can particularly fall victim to macroeconomic and geopolitical shifts, such as the global energy supply shortage spurred by the Russian invasion of Ukraine, as well as inflation and interest rate risers. 

The ACCC shared its concerns when identifying the investigation of greenwashing as a key 2023 priority, stating that “some businesses are falsely promoting their environmental, green or sustainable credentials in response to consumer demands.” ASIC has also issued a warning to company directors and executives regarding its priority to enforce greenwashing further, after issuing a number of infringement notices. 

The ESG trend is also experiencing some political backlash, especially given the energy supply crisis. Australian Opposition leader Peter Dutton, recently declared that the country “deserves an honest debate on energy” and that “the business community should be starting down the extremes of ESG, proxy voters and industry super funds demands on capital and stand up for the national interest.” US President Joe Biden used the first veto of his presidency to reject a Republican proposal to block pension fund managers from basing investment decisions on areas like climate change. 

And back to the all-wide net that ESG casts, there are concerns that the ‘E” in ESG investing has been prioritised over other elements, seeing other key factors given less prominence and profile when identifying ESG-related risks. One example is in renewable energy companies that source supplies from countries with horrific human rights abuse violations. 

An underlying factor in all of the above concerns is that ESG is wide-ranging and can mean different things to different people. There is no simple test, and no explicit universal standard for qualifying a stock as ESG-friendly. 

The upside

Still, investors see the upside – not only in directly aligning themselves and their money with ESG goals but also in potential opportunities for long-term returns, given ESG’s inherent link to the future health and wellbeing of the planet. 

Atlassian co founder and billionaire Mike Cannon-Brookes told an August Australian Institute of Company Directors climate forum that companies with poor ESG scores generally have higher financial risks. Cannon-Brookes’ private company Grok Ventures retains a 10% share in Australia’s largest carbon emitter AGL, and he has been the company to move forward power station shutdowns and move to a faster plan on decarbonisation. 

Meanwhile, the appetite for what an ESG framework delivers is strong. ESG investing principles are attracting an increasing number of retail investors in Australia from those who are favoring companies with a positive impact and avoiding those perceived to do social and environmental harm, according to the 2023 ASX Australian Investor Report. 

Two thirds of retail investors declared they are willing to consider sustainability when investing, according to the study, with asset managers leveraging ESG filters to make responsible investment decisions. 

ESG-focused funds also have increasingly significant power over companies to push them to do better, by challenging listed entities that are failing on key environmental, social and governance issues. The Australian Council of Superannuation Investors (ACS), for example, recently announced a new voting policy that would see companies facing recommendations ‘against’ the re-election of male directors where women do not occupy at least 30% of board seats. With more than $1 trillion in funds under management, this is a powerful move by ACSI. 

How to be a savvy ESG investor?

Being ESG savvy is far from straightforward, for all the reasons listed above. 

But it can be rewarding, in terms of taking an active interest in environmental, social and governance factors, and deciding to place some priority on which companies are addressing these things. 

There is no way to easily determine the ‘best’ or ‘most ESG’ related stocks for investors, as every investor will have different ESG priorities. 

However, there are a number of key trends that link them, as well as a number of key stocks across the ASX 200 worth checking out. 

Investors need to go further than the PR and marketing behind a stock to determine its true ESG rating and cast a critical eye on various factors and sources, including company reports and annual meetings. 

ESG-aware investors will also keep track of prominent business publications and third-party reports to see how key companies are performing and to keep up with key issues that are emerging. 

It takes considerable work to determine the ESG performance of individual stocks across a large portfolio, which is why trusted ESG ratings can be beneficial. 

Measures and benchmarks that may be considered in ESG investing 

Has the company publicly issued a net zero emissions pledge? 121 entities across the ASX 200 have now done so, according to research by the Australian Council of Superannuation Investors released in August 2023, this 61% figure is up from 48% in the year before. 

Is the company taking action to reduce modern slavery? The ACSI has released an annual scorecard on addressing modern slavery, finding just 19 ASX 200 companies score 30 points or more on an achievable 46.5 points on addressing modern slavery.

Has the company achieved at least 30% women on boards? 143 boards on the ASX 200 have now reached the 30% target, according to the latest Gender Diversity Progress report from the Australian Institute of Company Directors. 

What factors come into ESG investing? 

There are three tenants to ESG: Environment, Social and Governance 

Environmental 

Here, investors will seek out ‘green’ credentials, examining an investment’s direct contributions to climate change through greenhouse gas emissions. Other areas like energy consumption, waste and water usage may also be considered. 

Social 

The social tenancy considers everything from diversity, equity and inclusion across the employee base, to how the company selects suppliers, supports the community it’s in and addresses areas like equal pay, health and safety. 

Governance 

The factors that may be considered under governance include transparency, compliance, clear mechanisms for declaring conflicts of interest and more. Executive pay, governance structure and anti-corruption policies may all be considered. 

ESG Risk Ratings. CMC Invest offers an ESG Risk Rating Feature supporting investors to understand a company’s exposure to ESG risks and ultimately to develop a socially responsible strategy. The risk score is identified through independent corporate governance research and ratings across different shares. 

Seek independent advice and consider the relevant Terms and Conditions at cmcmarkets.com.au when deciding whether to invest in CMC Markets products. CMC Markets Stockbroking Limited (ABN 69 081 002 851 AFSL No. 246381).