It’s not often, in my experience at least, that a conversation with a stranger on a long-haul flight turns out to be both useful and edifying from a professional perspective. But that’s what happened to me last week as British Airways ferried me from Singapore to London.
The engaging fellow seating next to me happened to be a private equity investor who focuses on Africa. Well, this column happens to be about Asia and, in order not to stray from my remit, I won’t expound on the similarity between the “Tuna Bonds” scandal in Mozambique and 1MDB in Malaysia. Instead, I shall share with you my travelling companion’s thoughts on Environmental, Social and Corporate Governance (ESG).
This gentleman was looking at ESG through the lens of the executive MBA course he is completing at various locations around the world, including Singapore, where he had just made a three-day visit to complete a module on “impact investing.”
Impact companies, in their purest form, are non-governmental organisations that pursue something of intrinsic value towards the common good. They sit at the opposite end of the spectrum from companies that think only of profits.
The aim of many companies these days is to try to occupy the space between these two extremes. It’s tough for me to consider that ambition without putting on the cynicism spectacles, so that was more or less my reaction to an MBA case-study involving a manufacturer of hip clothing for mountaineers and surfers that is known for its right-on attitude.
Surely such clothing doesn’t score very well on the “E” element of ESG, given its products depend on fabrication from refined petroleum. But the company uses its products to vocalise its pro-environment stance, and apparently encourages the owners of its clothes to repair them rather than chuck them out when they get worn or damaged.
In that way, the company scores highly in the societal impact stakes, even if it achieves a low score in the environmental impact stakes. And there are companies out there busily compiling impact scores to help consumers and investors decide where to spend their money.
Alongside that, the big credit ratings agencies are trying to find ways to incorporate ESG analysis into their methodology. That’s no small task, because no one can agree on precisely what objective measurements to use. And according to the gent on the plane, there is an inverse relationship between the “E” and the “S” in ESG, such that the better a company scores on the latter the worse it tends to score on the former.
The example he gave me was of say a Unilever or a Nestle successfully marketing milk powder in an Indian village (it could just as easily be African) and thereby having a significant societal impact by training the locals in the marketing of that powder, contributing to poverty reduction. The downside is the manufacturing process of the powder with its attendant risk of pollution, utilisation of scarce water supply and so on. There’s your inverse relationship in action, and its a tough one on which to apply objective measurement criteria for ratings purposes.
Mind you, we’ve heard that complaint in relation to Green bonds, whereby third party verifiers of just what constitutes sustainability and environmental friendliness apply a smorgasbord of measures. It’s that situation which allows, to take one example, the proceeds of a Green bond to be used in part to fund coal mining, which has happened in China’s Green bond market.
And in my travels around the ESG fraternity the cry for the unification of definitions and accepted measures is everywhere; as ESG becomes ever more fashionable in the boardrooms of corporations and institutional investors you’d have thought all that would have been sorted out by now.
Going back to impact investing, I also learned that of the roughly US$73trn sum total of global investment funds, only half a trillion is invested with impact thinking as a consideration. That left me thinking that the whole thing represents a definitional game that comes straight out of the philosophical musings of Ludwig Wittgenstein. You widen your criteria, or narrow them, and that second statistic inflates or deflates accordingly.
Still, despite my suspicions that there is a racket going on in ESG labelling, the direction is clear. A variety of ESG equity indices from a wide range of institutions including Barclays and MSCI have outperformed in recent years – although there’s some debate about whether the collapse in oil prices might have something to do with the underperformance of the “brown” sector.
There is no doubt that the investment universe is embracing more responsible practices, but raising the proportion of dedicated funds is always going to be a long haul. Now what we need is to know how and when to focus on ESG, SRI (socially responsible investing) or impact investing. Perhaps my companion will find the answer to that question on the next leg of his educational travels.
