Should sustainable investments in times of climate change focus exclusively on environmental topics (E for environment), and more so, only on (CO2) emissions, as recently suggested by an article in The Economist? What role do social aspects play in the evaluation of companies apart from ethical considerations?
Tarot vs. ESG investments
Imagine you are playing the card game tarot for the first time in your life: dozens of rules, everyone else has played for years, and it sees impossible to catch up with them – where is the fun in that? You now have two options: you can invest a lot of time and seek advice in order to master the game. Or you can forget about it and hope that everyone else will do so too, apart from a small community. After all, it is just a weird card game that only weird people play. This seems to be the experience that some newcomers to ESG have.
Making one’s own rules
Due to this complexity of ESG investments, one might be tempted to reduce and standardise things as much as possible: could ESG kindly only focus on emissions? Then we could concentrate on the essential things, and mankind would be saved from climate change. But does it make sense to use one single key ratio across an entire sector?
Not everyone is equal – the concept of financial materiality
When you are talking to experienced tarot players you will find that they are happy to share their know-how in order to get new players. The same is true for ESG analysts, which is why I would like to discuss the concept of financial materiality at this point. What matters to the ESG investor is how the (changing) environment affects the respective company. If I hold an energy company, I have to ask myself how future regulations geared towards the compliance with the Paris climate goals will impact this company. If, on the other hand, the company is a bank, CO2 emissions will not affect the financial aspect of my holdings, but the loans outstanding from companies in the fossil fuel industry might do so. This concept is called financial materiality – it is important to find out which ESG factors are relevant for the respective sector and to let this finding inform one’s investment decision.
Imagine a tightening labour market
It does not take much imaginative power for this scenario – in fact, it describes the current situation in the USA, also referred to as “the great resignation”, pretty well. Do you think that companies with little fluctuation that are attractive to talents will have a competitive advantage during that phase? If so, you will take these social factors into account when evaluating the company on top of ethical considerations. Admittedly, there are sectors where the demand for innovative talent and the competition for it are bigger than in other sectors. Still, social factors are a fixed component of our qualitative ESG analysis, because they contain information on the attractiveness of the employer as well as on the quality of production.
ESG is as multi-layered as life
From our point of view, investments that allow child labour in the supply chain, violate human rights, give money to arms manufacturers, or let forced labour slide are no sustainable investments. Therefore, at Erste AM we have the rule that all our sustainable funds, regardless of their structuring or strategy, must fulfil these minimum social standards. We hope that our approach will be confirmed as benchmark for sustainable investments by the Social Taxonomy, which is being developed by the European Commission as we speak. We expect the attractiveness of the companies that already fulfil these criteria to grow further.
Therefore, we have decided to focus the ESGenius Letter on the “S” in ESG and hope you will enjoy reading it over summer.
For a glossary of technical terms, please visit this link: Fund Glossary | Erste Asset Management
Prognoses are no reliable indicator for future performance.