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August 4, 2020

ESG Means ‘Extremely Strong Gains’

Summary:

While ESG actually stands for environmental, social and corporate governance considerations, it delivers major benefits to practitioners.

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Global institutional investment is increasingly influenced by environmental, social and corporate governance (ESG) considerations, with sustainable investment now exceeding $30 trillion. That’s up almost 70% since just 2014 and up 10X since 2004; within these figures, the insurance sector forms a significant share of overall investments.

Further, sustainable investing’s market share has also grown globally and now commands a notable share of professionally managed assets in each geographical region, ranging from 18% in Japan to 63% in Australia and New Zealand, according to the Global Sustainable Investment Alliance (GSIA). Clearly, sustainable investing constitutes a major force across global financial markets.

While dedicated ESG funds remain a small part of the global stock market, the broader trend is toward all asset managers becoming more focused on these issues. ESG-focused equity funds have taken in nearly $70 billion of assets just over the past year, according to EPFR, while traditional equity funds have suffered almost $200 billion of outflows over the same period. 

This enormous swing in investor focus can be attributed to better awareness and consequent commitment on the part of companies and investors. Companies have come to appreciate how socially responsible investing can protect their long-term futures through sustainability. 

Out with the old, in with the new

Investors have seen these investments gain traction and allocated a part of their portfolio to them. Society, too, has collectively decided that it’s tired of the old “exploit to the max and then discard” model and has demanded a paradigm shift toward the “people, planet and profit” model.

These beliefs seem to have become stronger still during the COVID-19 pandemic, with people having more time to reflect. So, the impact goes beyond the balance sheet to include customers’ buying habits and employees’ attraction to work for companies that share their values. 

Don’t think, however, that these huge asset allocations to ESG investments are driven solely by some sort of macro-level conscience shift, with megafunds piling cash into them to salve their conscience, or that the investment community is buying into these funds purely on the basis of some kind of karmic compensation. 

The reality is quite the opposite. So much so that we could reasonably start interpreting ESG as “extremely strong gains.” 

See also: Crisis Mitigation Beyond COVID-19

A recent McKinsey report has digested more than 2,000 studies of the impact that ESG propositions have on overall equity returns and has found that 63% of the studies concluded with positive findings.

Many healthy, stable and profitable firms with poor cash flow management can struggle to survive an unforeseen dry spell with little or no cash coming in, as we have witnessed through the forced lockdown and consequent shuttering of businesses around the world as a result of the COVID-19 pandemic. McKinsey’s years-long research on the subject reveals that ESG drives cash flow in five significant ways.

Driving top-line growth

ESG-focused companies stand in good stead with both consumers and governments. On the consumer side, that means it’s easier to consolidate market share, ward off competitive advances and launch products. The companies’ good social standing also favors more rapid approval from governments in terms of regulatory approval and licenses, making it easier to expand into new territories, thereby expanding their global footprint and further diversifying their revenue streams.

Reducing costs

Effectively harnessing the “E” (environmental) in ESG can reduce a company’s operating costs, with the savings going straight to the bottom line. Clearly, newcomers to the ESG party are likely going to have to swallow some significant one-off adaptation and business process reengineering costs, but the long-time converts are already seeing the benefits. As McKinsey notes, FedEx is making a determined push to have its entire vehicle fleet running on electric or hybrid engines, and the 20% that have already been reconfigured are delivering savings of 190 million liters of fuel annually.

More nimble legal and regulatory approvals

Strong and meaningful ESG engagement enhances a company’s public image, and this can help grease the administrative wheels when entering new markets or applying for operating licenses in sensitive or highly regulated sectors. And governments looking for allies in public-private partnerships are logically going to get into bed with organizations of good social standing ahead of their less transparent and committed competitors. Supervision or intervention by governments in critical industries is less likely to affect companies that focus on the “G” (governance) in ESG, and poor relations with governments can ultimately cost millions in terms of legal appeals, rejected takeover approvals and corporate reputation.

Engaged workforces

People want to feel good about the companies they work for. Organizations that deliver on the “S” (social) in ESG enjoy higher productivity, and higher productivity translates directly into higher earnings. Not to mention talent retention and acquisition, which is critically important to those companies seeking in-demand profiles to spearhead their digital transformation strategies. 

Conversely, organizations that leave the social dimension aside in the ruthless pursuit of profit will trip themselves somewhere along the way: Weak relations with staff will potentially lead to more strikes; poor supervision of outsourcing collaborators can disrupt supply chains; and consumer sentiment can wane quickly in an economic slowdown.

Better investment frameworks

A solid ESG proposition can boost a company’s investment return by directing capital to promising opportunities that can offer outsized yields as a result of getting in on the ground floor. Refreshing investment capital allocation can also help prevent expensive write-downs on historic investments that have reached the end of their useful life. Better to adapt and spend now than run the risk of having to play catch-up later down the line.

MAPFRE’s commitment 

At MAPFRE, we have committed to stop investing in electricity companies in which more than 30% of its income comes from energy produced from coal, nor are we going to insure new coal mines or the construction of new coal-fired power generation plants.

MAPFRE also has a mutual fund, Capital Responsable (“Responsible Capital”), which follows on from the existing Good Governance Fund and is complemented by a pension scheme and a mutual society (EPSV). The fund is the first of its kind to be launched in Spain and will invest in the shares and fixed income securities of European companies selected on the basis of their ESG attributes.

The Mapfre Inclusion Responsable fund invests in profitable European companies that pursue the inclusion of people with disabilities in their workforce. The goal is to demonstrate that, in the long term, companies that take these factors into account are much more sustainable and profitable than those that do not.

MAPFRE and, we believe, increasingly others, too, will continue to invest in ESG for the good of society but also for the extremely strong gains that will surely follow.

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About the Author

José Luis Jiménez is group chief investment officer at MAPFRE, the largest Spanish-owned insurer. He is responsible for the management of more than 60 billion euros.

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