The ESG Advocate 017 - ESG investing, double materiality and an omen 😈
Stakeholders broadly define ESG. Understanding your stakeholder categories and sub-categories can help your company address risks and create new opportunities. For both private and public companies, one critical stakeholder group is investors. As investors go, so do the world's companies, and investors are not slowing down regarding ESG.
This leads us to a few reads this week that support PwC's Asset wealth management revolution ESG report. I enjoyed this report's overall layout, which lists ten ESG trends and predictions, followed by four actionable steps for Asset and Wealth Managers.
Plus, double materiality is coming and adding to the confusion, and we look at a stark omen for investors supporting anti-ESG companies.
Let's get to it!
ESG investing isn't slowing down 🚄
Last week, we looked at how the threat of recession is looming on a CEO's mind. Do investors know something about ESG that CEOs are missing? Quite possibly.
In the first point, PwC states that "ESG is poised to become a key market driver" and that investors need "to understand how to capture the shift to ESG as a counterbalance to potential portfolio underperformance." This idea appeared in a mind-melting Harvard Law School paper on sesquimateriality (seriously, you have been warned). In other words, ESG considerations across a portfolio could help weather underperformance while driving targeted change.
PwC also states that 60% of investors report that ESG has "already resulted in higher yields" compared to non-ESG options, showing value in ESG for both companies and investors. Let's take a look.
For companies, The Globe and Mail recently asked some experts why ESG outperforms, and here are the reasons they list:
ESG provides downside protection during a social or economic crisis per this NYU Stern meta-study
ESG is an indicator of a company’s quality of management
ESG management is linked to business practices, such as talent acquisition and innovation
Lowers risk of instability in the sourcing of raw materials
Employee engagement at these companies tends to be higher
For investors, FTSE Russell published a similar report to PwC's but included this graphic to explain the rationale for sustainable investment.
It might be frustratingly obvious for practitioners that ESG is tied to these results. Still, I'm glad to see it laid out so well against the current global economic outlook because, hopefully, what investors already know will alleviate CEO fears and get them moving. Which company wouldn't want to be known for being a strong, stable investment during a period of instability?
The story matters📖
There's a common refrain that ESG manifests itself in the data. You can't manage what you can't measure. This is why metrics and disclosures are so critical. Collecting data is a part of it, but not the goal. Impact, whether long-term financial resilience or sustainability, is the goal.
This is where the sixth and tenth points of PwC's report come in. Firms (and their investments) must collect more data from more places to differentiate themselves, which means higher operating costs and fees. Data is largely unavailable unless reported (typically annually) in CSR reports or all over the place in alternative datasets, like climate models, social media, supply chains, etc. Also, analysis of the data is as critical as the data itself.
Data analysis has many challenges, but uncovering materiality is critical. After all, measuring and managing your environmental footprint might have a different material impact, depending on your company and industry.
For example, managing waste is way less material for an insurance company than a manufacturer (unless said insurance company is REALLY bad at it). Both companies should manage their waste footprint, certainly. For the manufacturer, responsible raw material use, reuse, and disposition is material to operations and possibly a regulatory issue.
Again, data is key. Anna Murray explains materiality and the critical intersection with data in her commentary, Despite recent debate, ESG investing is here to stay.
Long-standing lack of availability, consistency or, in some circumstances, relevance (ESG information that is material for one company or asset class may not be relevant for another) continues to be an issue.
Imagine a manufacturer measuring their waste, creating a new circular path for some of it, and then telling a story around the process and progress. The resulting transformation story sparks investor and stakeholder interest built on the relevant data.
The story matters, and data is the proof of your story. In some ways, it shortcuts others' analysis. This leads us to Dan Atkinson's write-up of how ESG narratives are needed in addition to the numbers (an assessment of Accomplish's report on ESG-related client behaviors) where Senior Fellow at the University of Zurich’s Center for Sustainable Finance Harald Walkate said this:
“Clients are asking ‘why?’ much more. Clients are increasingly interested in the narrative side of things, the stories to go with the numbers.
The story is where the impact (ESG or sustainability) comes to life. It is also where intentions become aligned, especially with stakeholder priorities. Financial services firms aren't exempt and can deliver the story through their products' transparency. Per the PwC report:
This could manifest itself in institutional and intermediary clients focusing more on solutions that demonstrably deliver positive real-world outcomes, informed by a theory of change, and seeking explanations of investment relevance.
Firms must have transparency on the goals and the impact their investment products drive. PwC calls this out in the tenth point. Mislabelling is rampant, and while institutional investors might know what they're doing, retail investors largely don't.
Engagement could be an accelerant to change🔥
PwC and Atkinson/Accomplish arrive at similar conclusions about quantitative and qualitative data that play into each other. Think about this section like this.
Quantitative = metrics/disclosures
Qualitative = the story
PwC states:
The current inefficiencies in quantitative data also reinforce the importance of setting out a clear vision and reporting progress against it in enriched qualitative disclosures.
Atkinson builds on this sentiment, outlines the differences between quantitative (screening), and drives it toward a shift in impact.
The report predicts that client behaviours will increasingly migrate toward the top of the observed behaviour scale, reflecting greater market maturity and understanding of how best to integrate ESG factors into investment decision-making. Broadly, this would result in a shift away from mechanistic solutions, such as negative screening, and a broader interest in empirical and qualitative approaches.
While ESG and sustainability are nascent for many CEOs, investors are getting smarter. With that might come a new stakeholder pressure to deliver on outcomes. I think we'll see a transition from screening and thematic investing to products that contain collaborative engagement elements. With so much interest in this area from investors, financial services firms can't wait for CEOs to catch up. PwC calls this out in their third point.
This trend towards a more investiable ESG landscape includes investing in companies that aren't sustainable now, and then helping them with the finance and expertise needed to incorporate positive ESG outcomes into their operations. Asset managers have the opportunity to take an actively interventionist approach.
That leads to an opinion piece about stewardship from Nicole Martens, a senior stewardship professional at Old Mutual Investment Group with a similar sentiment.
Collaborative engagement – whereby investors collaborate to drive a certain outcome from investee companies – is a critical stewardship escalation tactic, and it must be driven by the asset management industry, almost forcing the hand of the investee company to come to the party.
Using capital, expertise, and collaborative engagement to get companies DOING something sounds glorious.
Check the PwC report out for yourself!
Double materiality is ESG + sustainability 🤝
Misunderstandings around goals and impact are common problems at the center of the anti-ESG movement and the frustration of activist investors. Larry Fink, CEO of BlackRock, called out this pressure last week, saying:
facts are not important with some subgroups in this country
Still, I believe a lack of clear communication about investment products is part of what has allowed the anti-ESG pushback to manifest so strongly. Where confusion exists, the story is lost and can be easily co-opted for exploitation. On the other hand, activist investors looking to drive change are equally upset after discovering what ESG means.
As with everything ESG, there is even more confusion at this intersection with the EU's definition of double materiality gaining ground.
Double materiality, whereby an investor doesn’t just screen for the environmental, social or governance risks facing their portfolio, but also measures its ESG impact on the world.
Per the article, Fidelity International, S&P Global, and Robeco consider double materiality, with others integrating the idea into some products. This is a significant trend that I think we'll only see more of as climate change ravages the world.
Kristalina Georgieva, the IMF’s managing director, gave us evidence of this issue and laid out the case for its consideration.
The world was moving from a period of “relative predictability – with a rules-based framework for international economic cooperation, low interest rates, and low inflation” into a new age of heightened economic fragility.
This would mean “greater uncertainty, higher economic volatility, geopolitical confrontations, and more frequent and devastating natural disasters – a world in which any country can be thrown off course more easily and more often”.
If your CEO isn't looking at ESG, they are likely miles away from double materiality. Still, this leaves us with a great question. Can any investor or CEO afford to ignore ESG and sustainability in their strategy? Let's find out.
A stark omen for the anti-ESG movement😈
With all this investor attention, some still refuse to see the value in ESG risk management and good sustainability practices. Let's wrap up with an omen for those embracing the anti-ESG movement with another investor example - venture capital.
ESG represents risk management associated with core business issues at the intersection of environmental, social, and corporate governance. If you are anti-woke, you are anti-ESG. If you are anti-ESG, you ignore core business issues, which leads me to this fascinating read and anti-ESG omen in the WSJ titled How a New Anti-Woke Bank Stumbled.
The premise of the example is simple enough - there is a market for retail banking customers with conservative values. Sure, why not? No disagreement from me here, as serving a niche market is a great idea!
For example, suppose you wanted to support DEI. In that case, you might look at SHE, which "seeks to provide exposure to US companies that demonstrate greater gender diversity within senior leadership than other firms in their sector." Similarly and relevant here, if you wanted to bank along conservative values, find a bank that does that.
However, that pesky ESG thing isn't about values but risk and opportunities. So what happens when you actively ignore it? According to what happened at Glorifi, you ignore social and good governance. A couple of striking quotes from this read point to ESG issues. Remember, this startup secured 'tens of millions of dollars.'
Let's unpack the red flags.
The pair lacked much experience in banking or technology.
🚩This is a governance issue. Disruption rarely occurs with outsiders, but it can happen. Would you invest in a bank's leadership team without ANY banking and technology experience?
It stumbled with products; for instance, a plan to make a credit card out of the same material used for shell casings failed when the company realized the material could interfere with security chips and potentially be too thick for payment terminals.
🚩I honestly can't tell if this gimmick is an environmental issue or a governance one, but just wow. See the first flag.
“I’ll protect what’s mine,” read a proposed print ad for the gun owners’ homeowners insurance discount.
🚩On the surface, this seems to be good stakeholder alignment, but the phrasing is curious. If the company is touting 'protecting what's mine,' how sure can you be that they have your back when a claim is filed?
But staffers began complaining about what they said were Mr. Neugebauer’s volatile behavior and drinking habits.
🚩🚩I'm stopping with this one as the founder stated that “The attacks on what I do in my home after 5 p.m. are beneath” The Wall Street Journal. Yet, we just went through a COO biting a man's nose off at a football game in the off hours, a serious governance issue.
This last example is a double-whammy, though. When you invite employees to work in your home and can't keep the behavior professional, you aren't healthily engaging your internal stakeholders. This sits with the social, too.
For another interesting omen about ignoring ESG, especially the G, don't miss what is going on with Nikola.
I suppose the lesson here is: investor beware!
Tweet of the Week
I've been on this planet for almost 50 years. As a Gen-Xer, it is no surprise that this has happened during my generation.
Be the change.
