What is responsible investment and ESG?
It all starts with a good understanding of what ESG is. For many investors, it has become a well-known acronym. ESG stands for Environment, Social and Governance, and the ESG criteria are the basis for Socially Responsible Investment (SRI). These criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Integrating these into investment processes is increasingly becoming the norm. After all, taking sustainability criteria into account leads to a more comprehensive analysis, resulting in better-substantiated decisions.
: Environmental criteria consider how a company performs as a steward of nature. They assess the extent to which a company takes its ecological footprint into account in terms of priorities and performance: energy and water consumption, production of CO2 and waste, pollution, etc.
: Social criteria examine how a company manages relationships with employees, suppliers, customers, and the communities where it operates. These criteria relate to the social impact of the company on all its stakeholders, such as respect for labour rights, health and safety, non-discrimination, etc.
: Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights. These criteria are an indication of how a company is managed, directed and controlled, with an emphasis on ethical rules and transparency, particularly in relations between management, the board of directors and shareholders.
How do ESG criteria lead to Socially Responsible Investments (SRI)?
An investment process that aims to achieve social and environmental objectives, as well as financial returns, is called Socially Responsible Investment. By applying a number of sustainability (like ESG) and other criteria, certain companies, organizations and countries can be screened. The results of this screening lead to their selection or exclusion from the investment portfolio. A concrete example of an SRI investment process is the one upheld by Degroof Petercam.
Degroof Petercam's approach for SRI is based on three different pillars.
- The first pillar is a strict assessment of sustainability at both company and country level.
- Secondly, we screen and make well-founded investment choices and exclusion decisions.
- The third pillar is our active engagement as a shareholder, e.g. in the voting process in shareholder meetings of a company in which we have invested.
Only the companies with the most advanced ESG management are then eligible. These companies are aware of the ESG issues they face, and they account for them in their business practices and strategic choices.
A responsible investment makes perfect sense, in terms of performance too
Until recently, many thought that using ESG criteria in their investment process, resulting in the exclusion of companies, was disastrous for the diversification of their portfolio and its returns. However, recent studies show that in the medium-term, including non-financial factors in your investment process is beneficial for performance.
How do we explain this? Sustainability analyses lead to a better understanding of business risks and better portfolio management. On the one hand, the SRI process makes it possible to improve the risk analysis and to optimize the risk-adjusted performance of a portfolio. On the other hand, it also makes it possible to refine the analysis of investment opportunities. Why? If a company's management takes a very proactive approach to environmental, social and governance challenges and develops a competitive advantage in this area, it is undeniably a guarantee of the quality of the company's management.
We are convinced that companies managed responsibly really have the capacity to outperform the market in the medium- to long-term. Sustainable investment therefore, clearly makes sense in a medium- or long-term investment approach, and it also adds an extra dimension to traditional analyses.