As we approach mid-2023, the relevance of Environmental, Social, and Governance (ESG) considerations has never been more prominent. Once considered a niche market for the largest global companies, ESG has now moved into the mainstream, being adopted by small to mid-sized, privately-owned companies as well.
The Rise of ESG Investing
The growth of ESG investing has been significant in recent years. According to JP Morgan, there has been a substantial increase in ESG-themed ETFs and aggregate AUM since 2016. This growth reflects a rising interest in sustainable investing among both institutional and retail investors.
Moreover, ESG investing is not just about aligning investments with personal values or societal goals. A growing body of evidence suggests that ESG factors can have a material impact on financial performance. For instance, JP Morgan has developed a quantitative tool, ESGQ, showing that stocks selected based on ESG criteria can outperform the broader index.
ESG Adoption and Company Initiatives
As of 2020, 88% of publicly traded companies, 79% of venture and private equity-backed companies, and 67% of privately-owned companies had ESG initiatives. More than three out of four (77%) small and mid-caps have a formal purpose statement related to ESG, and nearly one out of five (18.5%) are using ESG standards, such as the UN SDG, GRI, or SASB. The breadth of companies embracing ESG is a testament to the growing recognition of its importance.
The Value of ESG
Embarking on a formal ESG journey is no small feat as it requires a significant investment of money and resources. However, research and statistics prove these efforts pay off in the long run. 80% of the world’s largest companies are reporting exposure to physical or market transition risks associated with climate change, and climate-related weather events are expected to cost businesses $1.3 trillion by 2026. Additionally, companies that put the United Nations Sustainable Development Goals (SDGs) at the center of their economic strategy could unlock $12 trillion a year in opportunities and generate 380 million jobs.
Consumer behavior also indicates the value of ESG. 76% of consumers say they will stop buying from companies that treat the environment, employees, or the community in which they operate poorly, and 88% of consumers will be more loyal to a company that supports social or environmental issues.
ESG and Corporate Value Creation
ESG factors can contribute to corporate value creation in several ways. According to McKinsey, these include top-line growth, cost reductions, regulatory and legal interventions, productivity uplift, and investment and asset optimization.
For example, companies that prioritize environmental sustainability can tap into new market opportunities and enhance their brand reputation, driving top-line growth. They can also achieve cost reductions through energy efficiency and waste reduction.
On the social front, companies that treat their employees well tend to have lower turnover rates and higher productivity, which can lead to cost savings and productivity uplift.
In terms of governance, companies with strong corporate governance structures are less likely to face regulatory fines or legal issues, which can protect their bottom line.
Investor Influence on ESG
Investors have played a significant role in the rise of ESG. ESG propositions positively impacted equity returns 63% of the time, and ESG-mandated assets could make up half of all professionally managed investments by 2025, totaling $35 trillion. This trend is present in dedicated ESG funds and general investor portfolios that now routinely incorporate ESG considerations as a baseline.
However, the rapid expansion of ESG considerations into investing asset classes and the murkiness of the current environment create challenges for companies. Publicly held companies may be uncertain if the questions received from stakeholders, particularly investors, are salient for investment and portfolio decision-making or if they are part of corporate governance expectations. It is also unclear when these factors might be concurrently true.
The Road Ahead
With 2023 poised to be a defining year for ESG, companies are now revisiting, expanding, and changing their market mechanisms. Privately held companies, infrastructure, and real estate projects are part of the same basic dialogue, indicating that the landscape is evolving rapidly.
As ESG continues to play a more prominent role in investor decision-making, companies are likely to face more complex questions from fund managers seeking to satisfy those who allocate assets to them for management. These questions often go beyond simple box-ticking ESG queries and delve into the company’s operational and strategic decisions.
Conclusion
The rise of ESG reflects a profound shift in the business and investment landscape, with significant implications for companies, investors, and society at large. As we navigate this shift, it’s clear that ESG is not just a passing trend but a fundamental aspect of how businesses operate and investments are managed. Companies that fail to embrace ESG risk being left behind, while those that do stand to reap significant benefits from increased customer loyalty and employee satisfaction
