ESG, or environment, social and governance, has grown to be one of investing’s top trends. Institutional investors and investment managers alike are putting more focus on issues such as labor’s rights in the development of infrastructure, or whether firearms investments are appropriate for teachers’ retirement systems, and safeguarding water, air and food throughout development, construction and operations.
But can you meet return objectives while also meeting ESG standards? This is a question being considered more often by investors as ESG edges closer to the mainstream.
Studies and research have found that ESG standards can drive returns, but skepticism remains as to whether investors can balance their fiduciary duty to meet return objectives while also doing good.
According to the United Nations Principles of Responsible Investing initiative, however, the answer to this dilemma may have more to do with style than substance. The issue isn’t whether ESG standards add financial value — they do — but rather, the telling of the story of how that value is created and its benefits for investors, companies and stakeholders.
“Despite the growth in engagement activity by investors, exactly how ESG engagement creates value is poorly understood,” notes the UN PRI report How engagement creates value for investors and companies.
The opening chapter in this story could begin with monitoring and reporting of ESG policy throughout the investment period. On the front end, there can be excitement to tout the adoption of ESG standards in investments, but there can also be a lack of follow through to keep investments on course to create that value — financial and ESG — as well as to show the value when it is created.
The UN PRI report suggests investors are increasingly aware of this problem.
“This shift in institutional investor practices towards ‘active’ forms of ownership indicates that institutional investors recognize that their fiduciary duty to clients and beneficiaries should involve purposeful consideration, monitoring and intervention regarding ESG factors affecting investee companies.”
A good example of how companies and investors can tell the ESG value story is GCM Grosvenor’s recent hire of Jorge Ramirez, the former president of the Chicago Federation of Labor and former vice president and executive council member of the AFL-CIO. Ramirez was brought on as a managing director to lead labor strategies for the firm’s Labor Impact Infrastructure business and focuses on originating, structuring and monitoring investments. Having a managing director level role to support ESG from investment to implementation and ongoing operations can help communicate the value to shareholders and stakeholders.
Another example is Aligned Intermediary, a firm headed by Peter Davidson who is the former head of the Department of Energy’s loan guarantee program. The firm sources and structures clean energy and water investments and monitors ongoing operations to ensure the investments go to plan. AI invests on behalf of sovereign wealth funds, pensions, endowments, insurance companies, family offices and foundations with more than $80 trillion in assets.
It is this monitoring of investments on an ongoing basis where the story of how ESG creates its value might be best told. Without it, the promise of ESG can fall through the cracks and contribute to the story of ESG’s value getting muddled.
If there is no ongoing monitoring of ESG policy, standards can be missed and value never created. But even if the value is created, it may not be communicated, and that creates another problem — an opportunity missed to amplify the ESG story to investors who may be considering such investments but pass because of a perception that the decision is a trade-off and would require a financial sacrifice.
Data points
Benchmarking organizations also play an important role in driving and telling the ESG story. Through creating ESG benchmarks and getting investors, companies, governments and other community organizations to participate, the ESG value story is communicated to a broad and growing network of stakeholders.
The Global Real Estate Sustainability Benchmark (GRESB) is one such organization. It provides ESG benchmarks across real assets, including infrastructure and real estate.
Part of the challenge GRESB faces is simply developing a common language that can best communicate the challenge and value in ESG. GRESB and its partner the European Public Real Estate Association recently updated their own frameworks to introduce new social and corporate governance indicators, such as gender diversity, health and safety of employees and assets, to provide investors with a wider set of information to monitor and manage the ESG risks and opportunities of their investments.
“There are a bewildering number of standards and frameworks for measuring and disclosing ESG performance in the market,” says Hassan Sabir, EPRA director of finance, and a partner with GRESB in developing a universal language for sustainable investing. “This first Gap analysis between the two most recognized initiatives in our industry is an important step towards ensuring we all use and understand a common language and metrics.”
Tying all of these elements together into a cohesive and easily communicated narrative of how these investments are driving environmental, social and governance, as well as financial returns is a step forward in communicating the value of these investments.
As the UN PRI report points out, engaging stakeholders with results drawn from implantation to monitoring to measuring to results is a key to moving the ESG story from being understood as a simple “box checking” exercise, to one that delivers real, tangible value, including financial value.
“Engagement is a relational process between investors and companies,” notes UN PRI. “The intra-organizational dynamics that take place within companies are therefore as central to the investigation of whether and how ESG engagement can create long-term financial value as are those taking place within institutional investor organizations.”
