- For many investors, the "E" in the ESG triad is the most significant.
- On the one hand, climate change has become an investment risk. On the other hand, companies with sustainable operations attract investor interest and benefit from a favourable political framework.
- Studies show that funds focused on companies with sustainable operations often perform as well or even better than conventional funds.*
Ever more investors are making sure that their money is used to support companies that operate in a climate-friendly manner. For many, environmental protection – the "E" in the ESG triad of environmental protection, social ("S") and corporate governance ("G") – is the most important issue.
Climate crisis as risk
When it comes to environmental and climate protection, companies both contribute and suffer. With targeted investments, they can actively help to reduce harmful emissions and lower consumption of natural resources. At the same time, the risk of them becoming a victim of global warming’s consequences is increasing. Floods do not stop at production sites, and workers are less productive in summer due to rising temperatures. Pollution and extreme weather conditions increasingly threaten the global economy. Because companies in temperate regions depend on global supply chains, their balance sheets may also be impacted to a significant degree.
Environmental damage is difficult to reverse and increasingly threatens the global economy.
According to a study by McKinsey, the 2003 heat wave cost the European economy around 15 billion dollars. In 2012, Hurricane Sandy caused a loss of 62 billion dollars in the US. Climate change has become a serious investment risk.
And extreme weather doesn’t just cause physical damage; climate change increasingly affects business-model development. Altered consumer behaviour, regulatory changes and new climate-friendly technologies are changing the composition of global markets. If companies fail to adapt to the changes fast enough, they risk losing their market position.
Insurance companies, charitable foundations and pension funds are already beginning to pull back from companies that don’t have a sustainability strategy. Many fear that certain companies, in CO2-intensive industries such as coal or oil production, for example, will become stranded assets. Their business model could collapse due to the climate crisis, ever more investors are withdrawing from them and their value could quickly slump.
Climate protection as an opportunity
At the same time, companies with an ambitious sustainability strategy benefit from investor interest. According to the Forum for Sustainable Investment, 219 million euros were invested in sustainable financial products in Germany in 2019. This represents growth of 30 percent on the previous year. Sustainable management now makes sense for companies from a financial perspective too.
In addition, politicians are further strengthening the regulatory framework and creating additional incentives to do business sustainably. For example, the EU Commission recently reaffirmed its goal of making Europe the first climate-neutral continent in the world by 2050. To this end, it intends to initiate investments totalling 1,000 billion euros in the coming years. Companies and investors should be able to benefit from these developments.
Cutting CO2 barely affects performance
So, what about retail investors? Focussing on the "E" in the ESG triad can be a very promising strategy for investors. The MSCI World Low Carbon Leaders, for example, excludes companies that have high CO2 emissions or manage a large amount of CO2 reserves. The index's carbon footprint is therefore meant to be 50 percent lower than that of the parent index. In the past, the index has performed just as well as the main index, even slightly surpassing it last year.
Europe is to be the first climate-neutral continent by 2050.
The same performance with less CO2
The MSCI World Low Carbon Leaders has historically performed as well as or better than the main index. The carbon footprint of the MSCI World Low Carbon Leaders is 50 percent lower than that of the MSCI World.
When emphasising the "E", investors should not, however, underestimate the influence of the other two factors in the ESG triad. Good corporate governance ("G") and social engagement ("S") often also influence and reinforce a company‘s efforts to protect the environment and climate. From an investor perspective, the "S" can also have a positive effect on the portfolio’s risk profile, while good corporate governance ("G") can be an additional positive influence on performance.
*Friede, Busch and Bassen: University of Hamburg "ESG and Corporate Financial Performance" (December 2015)