What is ESG and why is it so important to investors?

When it comes to investment, it’s not all about risk, yield, and performance. Conscientious investors are now increasingly taking into account environmental, social, and governance (ESG) factors and focusing on the wider impact of how they choose to invest their money.

The term ESG was first coined in 2005 and is now firmly in the everyday financial lexicon. Interestingly, ESG has its origins in Ireland, as religious orders and charities sought to invest their money responsibly back in the 1980s and 1990s.

"They were naturally screening out things like alcohol, tobacco, anything with negative connotations, so that they could be comfortable with how their money was invested," Bernard Walsh, head of pensions and investment at Bank of Ireland, explains.

In recent years, the focus on ESG investment has accelerated considerably; about a quarter of all assets managed globally took ESG factors into account in 2016. Walsh says this proportion will only increase as time goes on.

“That is going to increase substantially. ESG is something that has emerged in recent years as a critically important way of investing,” he explains.

“Legislation has been introduced at a European level that requires fund managers to adopt ESG as a main factor when they invest money, but we are finding more and more that the customers we meet are bringing it up as an issue. Ten years ago, it was maybe one in 10 customers brought it up, now it’s one in two.”

Recent research suggests that millennials, perhaps unsurprisingly, have a very strong focus on ESG as an important criterion when it comes to how their pension fund or any lump sums are invested, citing issues such as climate change. “Irish investors are acutely aware of this, and keen to see their money invested in a socially responsible way.”

And it isn’t a case of E, S, or G; when it comes to ESG, companies must fulfil all three criteria, notes Walsh.

‘Big questions about governance’

“You can take a company like Tesla that ticks a box from an environmental point of view but there are big questions about governance such as the formation of their board and the size of the salary their CEO Elon Musk was taking out of the company.”

Indeed, governance is an issue that can sometimes be forgotten about, Walsh says. “Diversity in a board of directors can lead to better outcomes for companies. So, when you look at if the company is being really well run and has diversity, that will point to there being better returns.”

ESG is now underpinning the majority of investment decisions, admits Walsh. “It’s not about screening out the irresponsible companies, now you are actively seeking companies who have a very good governance records, and those that have a track record of being socially responsible, and that are making active decisions to improve the environment.”

Companies that meet all these criteria will reap the rewards in terms of attracting investment, he adds. “Irish companies are taking this on board.”

But ESG investment is not just about being environmentally or socially conscious – it makes sense too from an individual investment perspective, says Walsh.

“What ESG will do will help us to avoid a situation where you have a company suffering from a major catastrophe that will drag down somebody’s investment portfolio,” he explains, citing the BP Gulf of Mexico oil spill as an example.

“As a fund manager, you are looking at the risks of holding a particular share and ESG gives you a really good lens when it comes to that. It can help you avoid major disasters when it comes to your portfolio.”