Traditionally, investors have used fiscal indicators such as P/E ratios, debt-to-equity ratios, EBITDA and other metrics to make informed investment decisions. However, as the next generation takes over the investing mantle, there is a psychographic shift in investing behavior and more attention is being paid to the environmental, social and governance (ESG) effects of their choices.
While a family should work with an investment advisor to determine the value of ESG investment options, below are data and other considerations to help frame the discussion surrounding the ESG investment world.
ESG investing is a growing category of investment choices for investors that merge environmental, social, and governance factors into traditional investment evaluations. This means investing in companies with a mission-driven purpose combined with the expectation of solid financial returns. This investment choice is sometimes used interchangeably with both “socially responsible investing (SRI)” and “sustainable investing”. The U.S. Forum for Sustainable and Responsible Investment reports that in 2018, $1 of every $4 invested in the United States were invested according to ESG criteria. ESG or SRI has gained significant traction in the last decade, and became even more prominent in 2020 given the social and racial inequities highlighted by the pandemic.
Environmental factors include understanding the effects of a company’s practices on the natural world around them. The Intergovernmental Panel on Climate Change (IPCC) concluded that human influence on climate has been the dominant cause of observed global warming since the mid-20th century. The main human influence has been the emission of greenhouse gases such as carbon monoxide and methane. As a result, high net worth (HNW) investors have used use metrics such as carbon emissions, pollution and waste practices to evaluate a company’s environmental performance.
Social factors involve evaluating the humanitarian aspect of a company’s business practices. Does the company benefit from unethical practices such as child labor? Does the company promote diversity and inclusion (D&I) in the workforce? Does the company’s supply chain ecosystem meet the same ethical criteria as the company itself?
Lastly, governance factors include evaluating the company’s internal business practices, such as the transparency of the company’s financial reporting processes, the prevention of conflicts of interest on their boards, and the assurance that the company itself is not engaged in any illegal activities.
The main question on the minds of critics of socially responsible investing is whether this investment strategy reaps positive benefits and financial return.
A report from Morningstar confirms that even during down markets in 2015 and 2018, around 60% of sustainable funds placed in the top half of their respective categories. Even during the market meltdown following the COVID-19 pandemic, more than 70% of ESG funds performed better than their counterparts between January and April of 2020, according to the Wall Street Journal.
Furthermore, almost 500 companies have added ESG language into their prospectuses between 2018 and 2019, and flows into sustainable funds nearly quadrupled over that same period. With the flurry of activity surrounding ESG funds, companies incorporating ESG criteria into a prospectus could make fundraising easier as more and more UHNW individuals look to invest their capital into funds that do good.
It is important to conduct thorough financial diligence when vetting a potential investment opportunity for its ESG criteria. This is essential, not only for realizing a return on the investment, but also to make sure that the organization is on good financial footing for the future and can be reasonably expected to continue to have meaningful impact. Choosing the right transaction advisory professional with the appropriate expertise can be instrumental in vetting and making informed ESG investment decisions. Anchin works with many mission-driven companies as well as funds that are dedicated to investing with core ESG principles.
Another unique trend by HNW investors is working with funds for a longer duration or with long-term perspective. An example of such a fund is NextWorld Evergreen, and as the firm’s website and partner Scott Donohue explains, “We believe in a powerful alignment between investors and entrepreneurs to develop responsible long term strategies that support equity returns and positive impact on ecosystem.” “Our 100-year structure allows us to invest without the traditional constraints of private equity. We are accountable for each investment we make, and our capital serves to generate returns and deliver value across generations.”
Besides endowment, private equity or venture capital funds investing directly into companies, other vehicles such as mutual funds are also driving ESG investing trends.
The Pax Ellevate Global Women’s Leadership Fund (PXWEX) is a mutual fund that boasts a portfolio of over 400 companies, all of which prioritize diversity and inclusion (D&I) efforts. The fund is tied to the Impax Global Women’s Leadership Index, which evaluated over 1,600 global companies for D&I criteria. Dutch-American IT firm Wolters Kluwer and Starbucks are just two of the companies meeting this criteria. With nearly $500 million in assets under management, this fund proves that there is a lot of investor interest in D&I.
While there is still a fair share of skepticism, many tout sustainable investing as a profitable and consistent approach. Investors are thinking more about how to leave a lasting legacy for the future generations, which goes beyond economic legacy or generational wealth. For more information or if you are interested in conducting financial due diligence related to ESG investing, contact your Anchin Relationship Partner or Lami Ajibesin, Managing Director of Anchin’s Transaction Advisory group, at 212.863.1402 or Olamide.Ajibesin@anchin.com to discuss best practices related to ESG and other investments.