How to invest in ESG sustainably

Singapore

IT IS quite impossible to miss the reference to ESG in the financial world today. More attention is being brought to the environmental, social, and governance - or ESG - impact of financing and investment decisions.

The global pandemic that dominated the headlines in 2020 was no deterrent to the ESG wave. In one indication, the number of commitments to reach net zero emissions no later than 2050 from countries and corporations doubled in 2020 from a year ago.

While the past prevailing perception was that ESG investing was mainly about corporate altruism, ESG and sustainability considerations have become "central to corporate decision-making", a Refinitiv report in September said. "Covid-19 accelerated this mindset shift by demonstrating that managing social and environmental challenges is essential."

This means that more than before, there is scrutiny behind investment decisions that go beyond traditional calculations of returns. When a corporation seeks to secure funding to further its business plans, financial firms and investors are asking too about their plans to ensure that they secure a more sustainable future for generations to come.

ESG is a broad umbrella term, and it is helpful to break it down before putting dollars behind it.

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To look at environmental impact is to consider how business expansion would impact climate change - from air pollution to biodiversity.

To consider social impact would mean asking if a product is being put together in a sweatshop with deplorable labour conditions. In sourcing for the raw materials, has there been underhanded raiding of a low-income community? Does the product promote social ill?

Finally, to scrutinise the governance aspect of businesses is to ask how a corporation is looking at diversity in its leadership ranks, and workplace inclusion. It also means asking if a business is adequately informing and engaging shareholders. Is there transparency in the disclosure, or is there cherry-picking of data?

These are the uncomfortable questions being asked of corporations today to determine the ESG impact behind their business investments and by extension, the capitalist pursuit.

Younger Singaporeans seem ready to ask them. A survey of Singapore millennials by OCBC's FRANK, for example, showed that 63 per cent of Singapore millennials are conscious about the environmental impact of purchased products.

The 2020 Russell Investments ESG survey, which polled some 400 asset managers around the world, showed that among ESG factors, governance remains the dominant factor. This reflects how company management has been a critical component in long-term enterprise value, the report said.

But it has noticed a reasonable uptick in the importance of environmental and social factors, reflecting the "secular headwind" for carbon-intensity industries such as the energy sector. Seventy eight per cent of respondents also said that they incorporate explicit ESG factor assessments systematically in their investment process. This is up from 73 per cent in the prior year.

The market is growing. Assets in ESG ETFs more than doubled in 2020 from a year ago to about US$80 billion, figures from JPMorgan showed.

With the growing market, retail investors, too, are starting to access ESG-linked funds to ride the trend.

OCBC found that average investment amounts into the Impact Investing portfolio - one of its RoboInvest thematic investments that was introduced in April last year - more than doubled from six months ago. Some eight in 10 of customers who invest in the Impact Investing portfolio are below 40, though OCBC RoboInvest investors above 50 years old have also ramped up their holdings over the last six months, the bank said.

Digital wealth adviser Endowus has also launched multi-asset portfolios offering ESG exposure via funds that it said it has done due diligence on. Endowus also lowers investment cost by cutting out trail fees - the fraction of the fund's annual management fee that goes to distributors.

Endowus pointed to its survey of over 1,000 in Singapore that showed while ESG investing overwhelmingly resonates with respondents, only 28 per cent hold any ESG funds. One key factor is that investors don't fully understand ESG investing.

Despite the buzz, ESG investments make up a relatively new asset class, so some caution is warranted. One big problem is that there remains varying ESG scoring methods. This makes it difficult for individual investors to assess fully on their own how robust are portfolios that label themselves as sustainable in focus.

Investors should read the fine print to ensure that ESG-linked investments are aligned with their own stance on sustainability. For example, OCBC's Impact Investing portfolio has exposure to Invesco Water Resources ETF, a fund that puts most of its money in the water purification industry. Investors have to decide if that is the ESG exposure they want.

The portfolio also holds the iShares Global Clean Energy ETF, which has an MSCI ESG Quality Score that is 7.9 per cent higher than the reference benchmark. But its index methodology does not exclude companies based on their business involvement alone. Investors should note too that the equity fund has a "very high" risk label.

What has lifted investor interest is that ESG-linked funds have performed well. Doing good is not a penalty on performance at this point.

Research firm Morningstar found that sustainable equity funds closed 2020 with a clear performance advantage against comparative traditional equity funds.

"Like any investment approach, sustainable investing will not always outperform over short-term periods," it said. "But over the longer term, ESG insights can help investors develop a more complete picture of a company, one not reliant only on financial indicators. ESG analysis can provide an early warning on developing environmental or social risks before they affect company value and can help evaluate the sustainability of a firm's long-term business model and how well a firm treats its stakeholders."

Likewise, Kelvin Goh, OCBC's head of wealth advisory, said companies with good ESG ratings also tend to be less susceptible to regulatory and legal troubles. "If you were to think about this from an investor's perspective, looking at investments with an ESG filter makes good sense."

• The Money Playbook is a new personal finance column that discusses how to take charge of your financial well-being. This is the fifth of an eight-part series.