Adrian Howard
April 13, 2022

The old myth that investors need to sacrifice some returns if they want to consider environmental, social, and governance (ESG) factors in their investment strategy has rapidly gone out of fashion. There’s now plenty of evidence that shows how a company approaches these issues plays a significant role in long-term performance.

The COVID-19 pandemic, and its impact on businesses, has helped demonstrate the importance of considering more than a company’s balance sheet when it comes to investing your money.

That’s why the world’s leading investors are increasingly focused on environmental, social and governance factors when they weigh up which companies to invest in. ESG factors are a set of measures to determine how a company behaves and manages its impact on people and the planet.

The coronavirus pandemic hasn’t been the only recent event to have pushed investors towards a greater consideration of ESG factors. A price war between oil producing regions, combined with renewable energy becoming more affordable, has led to increased investment in green energy production.

The election of Joe Biden in the US marked a departure from the previous administration’s attitude to climate change, and under new administration the US has already re-joined the Paris Agreement and pledged new emissions targets for 2030. In addition, a number of commentators expect the US to introduce mandatory ESG reporting in the near future1.

Other countries have also indicated shifting attitudes towards the environment. The UK government’s Spring Budget included a number of initiatives aimed at promoting the ‘Green Economy’, including an infrastructure bank and grants to fund research and development in areas such as carbon capture and offshore windfarms.

At the same time, consumers are increasingly considering environmental and social factors in their decision-making processes. Companies seen to ‘give something back’ win more customers and, in turn, improve their bottom line.

All this suggests the global economy is creating a more investor-friendly landscape for socially and environmentally conscious companies.

While the environmental component of ESG tends to hog the headlines, the ‘G’ – Governance – is often overlooked when, in fact, it is just as important for investors.

A look over recent years shows a litany of companies suffering due to poor governance. The 2018 collapse of UK company Carillion, the largest ever trade liquidation in the UK, is perhaps an extreme example of what poor governance can lead to, but it helps shows the perils of chasing short-term growth at the expense of longer-term thinking and strong leadership.

Having your cake and eating it too?

While all of this theoretically means that investing in line with ESG principles should lead to better returns, does this bear out in reality? An increasing amount of evidence suggests it does.

First and foremost, this belief is shared by most fund managers. A survey of 104 fund managers by the investment consultancy firm, Redington, revealed that 73% of managers believed ESG integration adds positively to financial performance.

Likewise, data from MSCI found that, in the seven years leading up to 2020, the top third of companies ranked by ESG ratings outperformed the bottom third by 2.56% per year2.

The pandemic is also accelerating trends that were already well underway, such as the move towards green energy and electric vehicles. These trends are part of the reason why studies also suggest that improved performance from ESG practices is more evident in the long run3.  Embedding ESG into the investment process is not a ‘quick win’. Instead, it requires extensive engagement between investors and company management.

The need for advice

Whilst considering ESG principles when investing has become more popular, challenges remain for individual investors looking to incorporate these into their own investment strategy.

For a start, companies have been known to exaggerate their ESG credentials to appeal to investors, more commonly known as ‘greenwashing’. Furthermore, the process for disclosing ESG practice is not yet subject to the same reporting standards and external auditing as financial accounts. This can make it challenging for a fund manager to form a clear picture of a company, but also raises the question of the subjective nature of ESG integration in investment decisions.

“We know there is still progress needed in the industry to better standardise ESG reporting.” says Sam Turner, Responsible Investment Consultant at St. James's Place. “Since 2014, we have assessed all our fund managers on how they identify ESG issues in the companies in which they invest in, evaluating the data inputs they use and how they engage with companies to better understand their business practice.”

All of St. James's Place’s external fund managers are signatories to the Principles for Responsible Investment, and are required to integrate ESG factors into their investment process.

“We believe integrating ESG factors into investment decisions plays a crucial role in effectively mitigating risk and finding new opportunities. in turn, this provides the foundation to provide sustainable long-term performance for our clients.” adds Turner.

When it comes to making the best choices and understanding exactly how responsible investing can help achieve long-term returns, you can speak to a St. James's Place Partner.

Our world is changing faster than anyone predicted. We believe responsible investing has a huge role to play in shaping a better world and building a sustainable future.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

1 Harvard Law School Forum on Corporate Governance, Biden’s “Money Cop” to Shine a Light on ESG Disclosure, March 2021
2 MSCI ESG Research LLC, 2021 ESG Trends to Watch, December 2020
3 New York University Stern Center for Sustainable Business, ESG and Financial Performance, 2021