The rise in ESG investing has demonstrated one thing very clearly: people will take an interest in where their money is going and what activities it is supporting if the cause interests them in the first place.
No longer are investments seen as black boxes that are chosen for decent financial returns alone. Where that money goes (or where that money does not go) is becoming an increasingly important factor for individual investors, alongside purely financial returns.
Investors realise that their money has consequences.
Everyone Loves A Sports Analogy
Passive Fans
In the pre-ESG era individual investors could be seen as the equivalent of passive sports fans. Someone who follows a team and will check up on their results but not take too much interest in the mechanics of the win or loss. That is, they would not watch the game itself but they would seek out the result later.
In the pre-ESG era the mechanics of their investments would be left to an asset manager. Investors checked in once a while to monitor their investments’ financial progress and make some small changes – if necessary – but the specific places where their money ended up was less of a concern.
As the idea of ethical investments began to take hold, however, a subset of investors demanded that their money was divested from specific industries (e.g. defence, gambling and gaming, adult industries, tobacco). In the early 2010s the idea of divestment spread to fossil fuel investments too [4]. Investors became slightly more interested in their investments but only from a negative standpoint: what do I want to exclude?
Active Fans
The notion of ESG has started to turn investors into truly active sports fans. ESG has formed the starting point for many companies to advertise their usefulness to society. Companies can start to demonstrate that they are benefiting the natural world, paying their staff a fair wage and having a robust corporate structure etc. NB – there is much to be done to improve ESG reporting [1,2,3] but crucially the fact that the idea of ESG exists at all provides a starting point from which that can occur.
This opens up a whole new dialog between companies and individuals. Companies are able to engage with investors and prove the usefulness to society, as well as the financial benefits, of investing in them.
With new levels of transparency investors have the ability to turn into active sports fans. Fans who actively watch the game and care about the spectacle, not just the outcome.
What’s the benefit to the investors of being more active?
Why do we invest in anything? Generally, expectation of future returns.
And why do we want future returns? To give us the resources to create desired outcomes in the future for us and/or those around us.
Those desired outcomes can include comfort in retirement, the holiday of a lifetime, donating money to charity, enabling your children to have a free university education, and more.
But what if your investments could also help create the world you want to see. Create desired outcomes that also enable you to enjoy peace of mind in a more comfortable future; for example, ESG principles include a more just and fairer world, a fully sustainable planet, and improved gender balance in the workforce. But these outcomes do not need to be limited to purely traditional ESG factors, they could also encompass other values. For example, support for financially sound local businesses or industries, specific medical treatments, local infrastructure projects, or disincentivising tax evasion.
It is important to note that the demand for financial returns will still be important, but non-financial returns will play an increasingly important role in investment decisions.
In order to achieve this future, a step change in investment transparency is required. This will allow individuals to track what their money is doing in real time, watch the ballet play out before them, and steer their investments towards a desired future that they would like to see.
Investment Complexity
The major roadblock to this reality is the complexity of the existing investment industry. Much of the individual pieces of information are easily available, but linking them up is an incredibly difficult thing to do.
For example, investment funds can contain hundreds if not thousands of individual holdings. Many of them will invest in other investment funds making it difficult to easily track where one’s money ends up. In other cases, some holdings will be large conglomerates which have many different operations that cover many different industries, so at first glance it is difficult to see what that company does.
What makes the process of linking all these information sources even more difficult is that they are presented in a myriad of different formats. At Green Finance Guide we are developing a new tool which is starting to link this information together, Search My Fund. See below for more details.
The information is out there it just has to be knitted together and presented in a coherent manner.
Conclusion
All investments are made in the belief that they will benefit the investor (and/or those close to them) in some way or another. Previously this was only seen through the lens of financial returns, however, ESG investing has opened up a new investing paradigm. Investing to benefit the investor by choosing investments or investment products which represent the future in which the investor would like to live.
Currently the investment industry is set up primarily for maximising financial returns. But a system encompassing non-financial gains is tantalisingly within reach, all we’ve got to do is join the dots.
What Green Finance Guide Are Doing To Help
Green Finance Guide is developing a new investment analysis tool, Search My Fund, to improve the transparency of investment funds. Our first task is to clearly detail all the holdings of an investment fund, not just the top 10 holdings. Therefore, allowing investors to start to get a clearer picture of where their money is going. This task is well underway with over 2,500 funds already on the site.
The second task is to link these holdings together to give the true picture of where one’s money ends up. Whether that is uncovering the final holdings of funds which invest in other funds or clearly detailing the underlying activities of large conglomerates.
Click on the image below to take a look at the current version of the tool.
References
- https://www.ft.com/content/2a8d7fac-5ab6-43e5-9e04-8e9b3adfd195
- https://www.lexology.com/library/detail.aspx?g=4c9a61f2-2a7e-4d7f-8aa3-0f192f4e196c
- https://www.fitchratings.com/research/banks/banks-need-harmonised-esg-disclosures-for-climate-stress-tests-28-10-2020
- https://www.theguardian.com/environment/2014/oct/08/fossil-fuel-divestment-a-brief-history