Environmental, social, and governance investing has become more popular in recent years. Many ESG investors are motivated by ethical and policy concerns. But I have been wondering: even if I am not an environmentalist, could ESG investing be good for my financial returns?
ESG credentials as a business booster
I think one point some financially driven investors overlook is that a strong ESG story doesn’t necessarily just add costs for a company. It could actually boost profits.
An interesting example is companies such as Oatly and Beyond Meat, which have emphasised their provision of alternatives to dairy products. There is a large and growing market of customers who want such products. Often they are willing to pay a premium for them. So while Oatly may have an ESG story, it’s the financial impact of that which attracts me.
FTSE 100 company and ESG investing
I think the same logic holds for the consumer goods company Unilever. It loudly trumpets its environmental policies, from ethically sourcing palm oil to helping smallholder farmers run their businesses. But for a consumer facing company such as Unilever, I think such moves are good business practice. It can tout its environmental credentials to shoppers and use them to support the premium pricing of its brands. It can also secure its supply chain.
ESG fund inclusion
With more money pouring into ESG investing, that means that ESG funds will likely continue to attract more funds. Indeed, so many funds now tout ESG credentials that the Financial Conduct Authority today announced a clampdown on how such funds are marketed.
With ever more money chasing a tightly defined set of companies, the law of supply and demand could kick in. Companies which are in the FTSE 100 index benefit from higher share demand because tracker funds needs to buy them. I think the same could be true of companies that market themselves as suitable for ESG investment. More demand in the market could help boost their share price.
ESG investing and progressive management
Another possible attraction to ESG investing is that a company’s ESG performance is a proxy for how forward-looking its management is. If management engages on social and governance issues, this argument goes, that could help assure accountability and financial performance.
The evidence for this is mixed, however. For example, a European academic study concluded that ESG performance did not necessarily correlate to share price performance.
Nonetheless, I continue to see some merit in focussing on companies which genuinely value corporate governance, for example. That could lead to more robust corporate decision-making processes. But that also points up a risk I see in ESG investing. A poorly run company could potentially seek to distract attention from that. It could shift investors’ focus to non-financial reporting measures such as environmental standards.
So while I consider a company’s ESG profile, as an investor my primary focus remains on how profitable I expect a company to be in future. I am hunting for companies where I perceive ESG investing and improved financial returns come together.
