The Ethical Investor: A look back on the ESG shocks of 2022 and what investors can expect in 2023
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The Ethical Investor is Stockhead’s weekly look at ESG moves on the ASX – this week’s special guest is Perennial partners co-head of ESG & Equities analyst Emilie O’Neill.
ESG and climate investing were thrust into new spotlights in 2022.
Global regulators introduced proposals aiming to reduce greenwashing in the fund industry as well as stricter climate target disclosures against a backdrop of Russia’s invasion of Ukraine, cost of living crises, energy markets in turmoil, pandemic fatigue, rising interest rates, political uncertainty, and a series of climate-induced disasters.
As US-based finance company Morgan Stanley Capital International (MSCI) puts it, “the large-scale trends shaping the ESG-investing world are well known at this point” – climate change risk, the road to net zero, growing existential threat of biodiversity, social inequalities, regulation, and controversy over what exactly ESG should be.
Interestingly, MSCI says more investors voted against corporate climate strategies in the 2022 proxy season (between mid-April to mid-June) compared to 2021.
“We found that investors tended to vote against climate plans in 2022 where the company’s emissions trajectory was misaligned with global temperature targets,” the firm states.
“The average proportion of votes against went from 3.1% in 2021 to 9.6% in 2022, indicating increasing uneasiness among some investors.”
MSCI’s analysis of the limited number of votes in 2022 (43 companies) suggests dissenting investors may have opposed corporate climate strategies that they felt were not ambitious enough.
In 2023, MSCI says it will be watching whether investor opposition to corporate climate strategies will continue to increase, or whether more investors give companies the benefit of the doubt on their climate plans in challenging market conditions.
It was a tougher year for ESG funds who are traditionally underweight energy and resources, however longer-term performance continued to hold up with ESG funds performing equal ifnot better than their mainstream counterparts over most asset classes.
Research from Goldman Sachs has highlighted the ESG vs. non-ESG equity flows since 2019 which is striking – three of those four years (including 2022 ytd) saw positive ESG flowsagainst outflows for non-ESG funds.
We know about one in every three equity investment dollars is now going into sustainable funds.
For ESG funds, there will be a greater focus on company outcomes and engagement activities that managers are having with their investments.
There is an increasing sophistication of the market and investors are wanting authentic, next generation products that don’t just exclude the bad, but actively seek companies that are helping to shape a better future. Investors want to see deep ESG analysis and linking ESG performance with fundamental performance.
For ESG themes, we expect cyber security to remain salient – this was one trend which started to creep up the priority list last year and is in focus now with some of the high-profile cyber security incidences we have had in the last six months.
Perennial Partners have been engaging with companies on cyber security for some time now to ensure businesses understand cyber security management.
We want to understand, who ultimately has responsibility for cyber resilience, is there executive oversight, what mechanisms to protect data are in place, is it a pro-active defence
strategy or are they just putting out fires?
We want to make sure companies are at least meeting minimum regulatory guidelines and that they are only holding sensitive customer information that is required.
All of this allows us to then come up with an assessment on a company’s cyber security risk management – we encourage companies to invest more in the area and make sure there
are lines of defence in place.
In 2022, we saw a huge focus on the environmental factors of ESG, particularly on GHG emissions, disclosures and transparency, emission reduction targets and credibility of those
Going into 2023, we will see a continued focus on the transition to net zero as an investment theme but also increased scrutiny around companies’ transition plans –particularly holding management teams to account for progression against targets.
Under environmental analysis, I expect more conversation on biodiversity, nature-based solutions and a company’s impact on the land, forests and marine systems.
There was a study that came out recently which said 80% of millennials and Gen Z’s (in the US) believe investment firms should influence ESG considerations in their company holdings.
However, as mentioned, there is more focus on authenticity, looking at the deep ESG analysis and shifting from a traditional ESG scoring approach which ranks companies on yes
or no responses towards a forward-looking approach of ESG assessment and engagement.
ESG is a great lens for understanding the culture of a business. We know that Millennials are prioritising social considerations with their employers – they care about work life balance,
diversity in the organisation.
They are very “values” driven – much more so than the older generation.
A company able to meet the needs of their workforce is going to have greater engagement and less turnover than a business that isn’t investing in their workforce.
Social issues continue to be important to ESG analysis despite environmental issues taking majority of the headlines.
Investors should take a wholistic approach to understanding all material ESG risks and opportunities and not prioritise one factor over another.