News & media Ignorance is Certainly Not Bliss When it Comes to ESG
In a recent article addressing the ESG backlash in the US[1], the Financial Times highlighted the growing rift between political ideologies on the place of environmental, social and governance (“ESG”) considerations in corporate and investment decision-making, with some Republicans arguing that applying “green filters” to business decisions compromises financial returns and imposes unnecessary constraints on corporations.
To some degree, this spurning of ESG has its roots in the quarter-by-quarter or year-on-year reporting cycle. These requirements have shortened and narrowed the outlook of companies by shifting focus predominantly to immediate shareholder return maximisation rather than long-term sustainability. The same myopic behaviours in election cycles only adds to the rift and noise.
This has led to the creeping misconception that maximising shareholder value (asset owners’ and asset managers’ fiduciary duties) and integrating ESG frameworks into an investment strategy are mutually exclusive concepts which, as noted in the article, is not supported by clear empirical evidence. This view has led to the mischaracterisation of ESG, its purpose and value to an investment process.
At Cordiant, we believe that ESG considerations and the actions which it initiates are not inhibitors to profit or return maximisation. Rather, ESG represents a more systematic approach to the consideration of not only a multitude of risks, but of opportunities as well, against a backdrop of a world that is increasingly dynamic and burdened by its own physical limitations. Our primary focus is, as investors in industries that touch on power generation and sustainability in a meaningful way, on environmental factors.
The inclusion of these material considerations does not represent a warping of investment priorities or decisions. On the contrary, when implemented thoughtfully, they allow for a more complete assessment of an investment or business opportunity. They increase the calibre of due diligence. By taking a view that extends beyond a quarter or a year, asset managers act in the best interest of their clients and as proper guardians of their capital.
At the most basic level, investing conscious of environmental risks is principally a risk management tool. In combination with traditional financial analysis, companies and investors that consider factors under the ESG umbrella have a wider-reaching and more comprehensive understanding of potential operational risks (be they climate-related, regulatory, resource-based or governance) and business opportunities. This improved understanding produces a more informed management team, one able to take preventative action or mitigate against the impact of potential risks: In short, a better run company that represents a safer investment opportunity, with risk-adjusted returns that are more representative of the business.
There is no escaping the fact that ESG is a somewhat clumsy term that combines multiple, often unrelated considerations into a catchall assessment. Efforts to amalgamate these factors to achieve a singular numerical or risk output–in an industry that thrives off singular outputs–necessitate a simplification and often misrepresentation of material considerations. This is further compounded by viewing these risks as separate from core business operations, positioning ESG as an optional additive rather than an integral part of a company’s ability to function successfully. That does not mean, however, that effective ESG integration should be cast to the curb; rather, approaches to it should be updated to reflect its purpose, which is to refocus on effective risk management.
The recent troubles surrounding Thames Water, for example, speak to a business that may well have accepted unnecessarily high environmental and governance risks. The reputational and financial damage to investors in Thames Water speaks to an investing framework that could well have benfitted from a heightened due diligence on “E” and “G”. To say this is not an overt political point. If anything, thorough due diligence for investments supporting retirement pensions and insurance policies should be resolutely non-political.
Proper ESG integration requires a thorough consideration of material factors–including an assessment of the applicability, severity and likelihood that a particular risk will transpire. At the end of the day, all risks become financial risks and companies (and investors) that do not properly factor the consideration of these risks into their businesses may soon face a rude awakening. Whilst ignorance may be bliss, “forewarned is forearmed” seems a more practical path to financial success.
[1] ESG backlash in the US: what implications for corporations and investors?, The Financial Times, June 11, 2023
