Helene Winch, Head of Responsible Investing, discusses the similarities and differences between two commonly-used terms in the world of responsible investment: ESG and sustainability.
Across the asset management industry two ‘terms’ have become increasingly common in recent years: ESG and sustainability.
Although these terms are often used in quite similar ways, they are in fact quite different.
Firstly, what is ESG? ESG is an acronym standing for the following three components: environmental, social and governance. The term ESG differentiates from the purely financial aspects of investing and acknowledges that environmental, social and governance-related issues can impact the long-term performance of investments. ESG assessments can be extensive, broad in scope and represent both the risks and opportunities.
One phrase often used is “ESG integration” which refers to the explicit and systematic inclusion of ESG factors alongside financial factors in the investment analysis and decision making. This could include considerations related to the structure of company boards, carbon emissions data and health and safety performance, alongside forecasted turnover, profitability and dividends (the amount of income returned to a company’s shareholders).
Sustainability is generally harder to define, but one way to think about it is through the framework of the United Nations Sustainable Development Goals (SDGs). In 1987 the UN defined sustainability as “meeting the needs of the present without compromising the ability of future generations to meet their own needs”, a definition which is as relevant today as it was then. The 17 SDGs range from “No Poverty” to “Decent Work and Economic Growth”, and are a strong, aspirational framework in which to view sustainability. Using this framework to assess Premier Miton’s investments allows us to consider the products and services provided by a company alongside the impact of its operations. Aggregating portfolio company alignment to the SDGs also enables us to assess the sustainability of an investment portfolio.
So in practice, what is the difference between the assessment of ESG and sustainability?
Using the example of a potential investment in a company that is available to the public, i.e. listed on a stock exchange, the ESG assessment will look across environmental, social and governance-related factors of a company when evaluating its performance. The assessment will look at areas such as carbon emissions data, pay ratios and staff diversity, among others. Asset managers can choose to outsource this to a third party, who often rely on publically-available data. Much debate has been had on the value of third party ESG summary scores and what they really represent. In our experience, these scores generally assess a company’s exposure to material ESG risks, with too little focus on ESG opportunities (for example production of electric vehicles or vaccines), and are overly influenced by the size, regional requirements and the quantum of reporting.
Sustainability assessments help determine a company’s alignment with and contribution to a sustainable economy through its products, services and operations.
For example, a renewable energy company with 100% of its revenues aligned to SDG 7 (Affordable and Clean Energy) can be deemed “sustainable”, whereas a fossil fuel company with 0% revenue alignment cannot. However an ESG assessment of both companies may well yield opposing results. If the renewable energy company is recently listed with a small market capitalisation, with limited resources to provide full ESG disclosures, and a small, founder-led Board of Directors it may receive a low ESG score. On the other hand, an established fossil fuel company with robust commitments to transparency and governance may receive a high ESG score.
Hence the confusion when the terms are used interchangeably.
At Premier Miton we aim for our funds to generally integrate ESG in their investment processes. For those funds with a primary focus on sustainability, we will use the UN SDG framework to assess the sustainability of each holding and report on the funds aggregate alignment to the SDGs.