Investors are waking up to the importance of sustainable investing and targeting companies with high environmental, social and governance (ESG) ratings.
The controversy at Facebook highlights that investing in ESG ‘laggards’ can mean your investment is more volatile.
Investors are increasingly realising that companies that take environmental and social considerations seriously and implement positive actions are reducing financial and corporate risks and are therefore more likely to represent more sustainable long-term investments.
Sustainable investing involves taking ESG factors and ethical considerations into account to better assess and manage risk with the aim of generating sustainable, long-term returns from socially responsible investments (SRI).
The result is an alignment of investor values with their investment objectives.
Index provider MSCI is a leading global ESG researcher and making sustainable investing easier by providing ESG ratings.
These ratings can help to identify companies that are acting responsibly and to avoid the ones where negative risks related to ESG factors can depress a company’s financial performance.
MSCI has a team of over 170 analysts worldwide assessing all of the stocks in its global universe on a ‘AAA’ to ‘CCC’ scale according to their exposure to industry-specific ESG risks and their ability to manage those risks relative to their peers.
Well before Facebook’s troubles with Cambridge Analytica had emerged, MSCI had warned of the risk that data breaches and regulatory action were potential problems for the social networking company.
MSCI had granted Facebook an ESG rating of just BBB – compared to Microsoft’s AAA rating.
“Given its entire business [is] focused on monetising personal information and online advertising, Facebook is exceptionally vulnerable to regulatory actions and user dissatisfaction in case of privacy and data breach. Facebook’s controversial data collection and advertising practices have continued to trigger user complaints and regulatory actions,” MSCI has warned in an ESG ratings report.
“With billions of users globally and majority of revenue from targeted advertisements, Facebook is highly exposed to risks related to privacy and data security.”
In contrast, Microsoft has a ESG rating of AAA.
MSCI said in a ratings report that Microsoft “remains one of the most attractive employers for strong employee benefits and programs as well as its technology leadership”.
Not only were Facebook users dissatisfied with Facebook after the recent breach of privacy of users’ data, but also US regulators.
The implications for the company’s share price were clear: immediate weakness.
Highly rated ESG companies help to drive returns
MSCI recently released a research paper, Foundations of ESG investing, which evaluates how ESG characteristics can help drive corporate performance.
The paper presents compelling reasons to include highly rated ESG companies in your portfolio.
According to MSCI:
- High ESG-rated companies tend to show higher profitability, higher dividend yield and lower idiosyncratic tail risks;
- High ESG-rated companies tend to show less systematic volatility, lower values for beta and higher valuations; and
- ESG rating changes — which MSCI calls ESG momentum — can be a financially significant indictor and a potential link to returns.
Other research supports these conclusions. Analysis from Credit Suisse finds that integrating ESG factors can enhance portfolio performance through both lower exposure to negative risks related to ESG issues and higher exposure to related opportunities, which can lead to material cost advantages, improved efficiencies and/or new revenue sources.
Credit Suisse also found that ESG ratings are a possible lead indicator of management quality in that companies which are better managers of ESG factors may also be better managers of shareholder capital.
Many active fund managers incorporate ESG factors into their risk analysis.
However, the challenge for many investors has been combining the inclusion of ESG leaders, exclusion of fossil fuels and high greenhouse gas emitters and the exclusion of companies involved in anti-social or irresponsible activities into one portfolio.
Many managed investments do only one or two of these. It has been particularly hard for passive managers, who track indices, to target ESG leaders.
The newly launched VanEck Vectors MSCI International Sustainable Equity ETF (ASX: ESGI) provides investors with exposure to a diversified portfolio of international companies meeting in-depth sustainability criteria with management costs of just 0.55 per cent per annum.
ESGI tracks a new benchmark index, the MSCI World ex Australia ex Fossil Fuel Select SRI and Low Carbon Capped Index, developed in partnership between VanEck and MSCI.
The selection process involves very high sustainability standards.
Companies are identified from the MSCI World ex Australia Index by a multi-layered screening approach as follows:
- Excluding companies with fossil fuel reserves;
- Excluding companies whose businesses are involved in non-SRI activities such as alcohol, gambling, tobacco, military weapons, civilian firearms, nuclear power, adult entertainment and genetically modified organisms;
- Including only the leading ESG performers in each sector; and
- Excluding high carbon emitters.
Several high-profile companies are excluded from the ETF’s Index, including Facebook. ESGI enables investors to more easily and affordably access an international portfolio of sustainable companies with one trade on ASX.
Arian Neiron is the managing director of VanEck Australia.