EQD Research Sponsored Articles

EQD Research: How The Corporate World Must Adjust To The Heightened Focus On ESG

Jul 30, 2021

By Russell Rhoads,
head of research

In the college courses I teach there is often a focus on corporate governance. When I was an undergraduate, we would learn the phrase, “Increase shareholder value”, as the major reason a public company exists. Since my time as an undergrad, the phrase has been expanded to, “Increase shareholder value and do no harm”. This is certainly a more appropriate statement for the current world. The Environmental, Social, and Governance (ESG) methods of investment analysis are rooted in the pursuit of profits while minimizing the impact on not just the environment, but a firm’s actions as a corporate citizen and how the company is run.

We are still in the early days for ESG investing but all indications point toward investors continuing to increase their focus on ESG when choosing both equity and fixed income investments. For example, the number of articles discussing ESG in The Wall Street Journal on pace to double in 2021 versus 2020 and almost triple in the New York Times (see chart below). Other anecdotal evidence notes that board elections are impacted by the perception of how well a company is doing with respect to ESG issues and even cryptocurrencies are now being scrutinized regarding their carbon footprint.

 

ESG exposure is easy to find and there are already several ETFs that offer access to portfolios that have screened investments with a focus on ESG scores. Asset growth in these funds also reflects an increased focus on ESG. For instance, collectively the largest ten US based ETFs focusing on ESG have increased the number of shares outstanding by 25% in 2021. Over the same period of time the most common ETF used to gain S&P 500 (SPY) exposure has slightly reduced the number of shares outstanding. A shift in interest in ESG investing is being matched by a flow of funds into these strategies.

A common concern when investors approach the ESG space is exactly what constitutes a good ESG score?  This uncertainty is also an issue for companies looking to improve their ESG score. The calculation methodologies vary greatly as do how different investors define an investment that qualifies to be included in a portfolio branded as being focused on ESG. Measuring the environmental or ‘E’ part of ESG is an area that may be debated, but reducing a firm’s carbon footprint is one way it may improve an ESG rating. A firm’s carbon footprint is also a straightforward measure of how much harm the firm is doing in pursuit of profits.

In order to guide firms on how to reduce their carbon emissions, SGX recently published a paper that offers some guidance to the corporate world on how companies can reduce their carbon footprint. Following the actions laid out in the paper should directly improve their ESG rating, regardless of the methodology. In the report Credible decarbonisation and transition for corporates in Asia, SGX notes that corporations will need to play a significant role in reducing greenhouse gas emissions. The report also highlights exactly how firms can adhere to the Paris agreement on climate change. Finally, the report lays out a six step process for corporations to take that will lower emissions and improve ESG scores.

A wider number of investors are becoming more aware of ESG as a methodology to help choose where to invest. If a company is operating under the, “Increase shareholder value and do no harm”, mantra they will be well served by consulting SGX’s guidelines as laid out in their recent report.

The full report Credible decarbonisation and transition for corporates in Asia may be found here