How to integrate ESG factors into investment decision-making

Simon Whistler, Senior Specialist - Infrastructure, Principles for Responsible Investment, explores some of the pros and cons of ESG investing and looks at how the investment industry is adopting to more responsible investing

Insurance Investorposted on Tuesday, June 16, 2020

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Insurance Investor: How relevant are external environmental factors when making investment decisions?

Simon Whistler: The first decision point [investors] are looking at is the risk return element i.e. are they making enough financial return for the risks they are taking with each particular investment.

Of course, there are a number of factors that influence both the level of risk and the types of return that you can get out of your investments.

Increasingly, we are seeing that the external environment - whether we are talking about the environment in the sense of climate change or political and broader societal factors - are all important parts of this decision-making process.

From a climate point of view, there are factors related to transition risk and the need to move from carbon intensive industries to investing in cleaner, greener areas over time.

Policy and regulatory changes will also have an impact on the types of investments that you can make and the returns on your investments over a long period of time – here we often talk about ‘stranded assets’ or assets that become financially unviable because of the green transition.

"There are a number of factors that influence both the level of risk and the types of return that you can get out of your investments."

You also have the physical impacts of climate change where we are seeing a number of investors taking into account physical climate risks such as natural disasters, flooding, wildfires etc.

These events are starting to have an influence on where investors may want to invest or the types of assets and companies that they are investing in given their potential exposure to these climate related issues.

On the political and social side of things, we are seeing a rise of populism in several countries, and in some ways the breaking down of consensus over the role of private capital in various parts of the economy.

We are also seeing societal pressures through the rise of social media and other technology, which elevates the voice that different stakeholders and people have in relation to companies and the way that they do business or provide services.

All of these elements factor in and ultimately go back to the question of what level of risk and return you can expect from a particular investment.

Insurance Investor: Do you feel that these issues are now more at the forefront of investors’ minds compared to 5-10 years ago?

Simon: They are definitely more at the forefront as the investment community becomes increasingly aware of environmental, social and governance (ESG) factors.

The ways sophisticated players are integrating ESG into their decision-making processes has increased awareness more generally across many investors and managers and they are becoming an increasingly important part of the decision-making process as a result.

In a number of cases where the investment cannot meet ESG criteria, or where the values of an organisation haven’t met them, investors simply won’t make the investment - or will put very stringent requirements on that investment to make sure that they are satisfied moving forward.

"We have made good progress in terms of growing awareness and education of the value of ESG"

That said, we aren’t quite at the point where everyone is doing this and putting it front and centre of their investment decision making process.  There is still work that we need to do to get the industry to move in that direction.

We have made good progress in terms of growing awareness and education of the value of ESG and other external environmental factors into investment decision making but there now needs to be a further step in terms of making consideration of ESG factors in the decision-making process more fundamental.

In many cases now, investors may still try to fall back on the position that ESG considerations are secondary to making returns, even when a large body of evidence suggests that there is no trade-off between the two.


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