It’s a noisy world for investors. Whether its climate change mitigation, electric vehicle penetration, the transition from a linear to a circular economy, or achieving the UN Sustainable Development Goals (SDGs), the debate on ESG investing has been pushed to the forefront of the investment industry.
But what seems to be missing from the discussion is how the rapid ascent of ESG into mainstream has been accompanied by a sharp rise in the volume of terms used to describe ESG.
Today, the investment landscape is saturated by a plethora of ESG-related terminology. To demonstrate this, we scoured five ESG-terminology guides produced by our industry peers. We collated all of their definitions to highlight the vast range of words used to describe ESG within the asset management industry (see Figure 1). And as investors wade through vague definitions, from ESG to sustainability, it is not surprising that many are confused.
Figure 1. The investment landscape is cluttered with a slew of ESG-related terminology
Source: Hermes as at January 2019. Note: the bigger the word, the more frequent it appeared in our research study.
Of course, ESG investing has long been with us. At Hermes, our history of ESG investing spans more than three decades (see Figure 2). We adopt a responsible approach to investing across all of our strategies: for example, our Global Equities ESG strategy has integrated ESG factors into its idea generation since its inception in 2013. In addition, Hermes EOS has been a pioneer of stewardship since 2004. That’s why we are well-placed to cut through the noise and provide some much-needed clarity on the various forms of ESG investing.
Figure 2. ESG investing: a 200-year history
In the past 20 years, the number of asset managers offering ESG strategies has grown by more than 400%1.That’s according to the Global Impact Investing Network (GIIN). The surge of ESG investing during this period can be attributed to the seminal report published by the UN Global Compact in 2005. It found that integrating ESG into capital markets resulted in more sustainable markets as well as better outcomes for societies. At the same time, the that showed ESG issues are relevant for financial valuation. Together, these two reports laid the foundations for the launch of the Principles of Responsible Investment (PRI)in 2006 – of which Hermes became a founding signatory.
That was 13 years ago. Today, the PRI is an established body, boasting more than 1,600 members and represents over $70tn assets under management. Governments and regulators are demanding that companies and their owners consider the wider ESG implications of their business activities by introducing or strengthening stewardship codes. For example, the UN SDGs were established in 2015, serving as a blueprint for significantly changing the world by 2030, while in the same year, 195 countries adopted the first-ever universal, legally binding global climate deal – the Paris Agreement.
What’s more, there is a growing body of research supporting the integration of ESG. In our recent research paper , we found that companies with good or improving social characteristics have tended to outperform their lower-ranked peers on average by 15bps per month, while companies with good or improving corporate governance have tended to outperform companies with poor or worsening governance by 24bps per month.
ESG is therefore no longer on the periphery of the investment management industry, it has become standard practice industry-wide: in fact, GIIN found that 225 investors invested $35.5bn in 11,136 impact investing deals in 20172.
Even though ESG investing has become standard practice among asset managers, a standard set of ESG definitions has not yet been established industry-wide.
For this reason, we have decided to wade through the noise and present our view on ESG investing.
At Hermes, we believe there are two mutually reinforcing strands of responsible investment management: responsible investment and responsible ownership. Together, these aim to generate sustainable wealth creation for the end beneficiary investor encompassing both investment returns and their social and environmental impact.
Prevalent responsible investment approaches can be categorised into four different – but not mutually exclusive – activities:
Another integral element to responsible investment management is responsible ownership – that is, being a good steward and owner of companies and assets through asset engagement and advocacy:
Figure 3. The Hermes responsible investing and ownership roadmap
Source: Hermes as at January 2019.
Armed with a better understanding, investors should be able to identify the four distinct approaches to ESG investing.
Importantly, our definitions highlight that our Global Equities team adopt a mainstream ESG integration approach. Indeed, we have followed this approach since the team’s inception in 2007 – long before ESG investing had entered the mainstream.
By combining quantitative tools with a qualitative assessment and active ownership of positions through our responsible investment and engagement specialists, Hermes EOS, we aim to achieve capital appreciation by investing in global equity securities with favourable ESG credentials. We use four main tools:
These tools allow us to follow a mainstream ESG integration approach – that is, incorporating ESG considerations alongside insights from engagement, valuation, growth prospects and market sentiment, among others. Our model favours companies with an attractive blend of these characteristics.
Our case studies below – Bank of America and Thermo Fisher – demonstrate the practical application of a mainstream ESG investing approach, where we have seen the significant impact that the consideration of ESG characteristics can have on our valuations.