Non-financial factors are being increasingly considered by investors when drawing up their risk assessments, which implies new challenges for capital markets.
By Valora Analitik for Grupo SURA*
Global investors are paying more and more attention to environmental, social and corporate governance practices, commonly referred to as ESG factors, when making decisions as part of their fund investment strategies.
Here, environmental criteria are used to evaluate the direct or indirect impact of a company on the environment, whereas social criteria apply to evaluating aspects affecting supply chains, human talent, human rights, while corporate governance criteria refer to the manner in which an organization is directed and managed.
BNP Paribas Securities Services conducted a study in which it predicted that asset management firms, insurance companies and pension funds worldwide shall double the amount invested as part of ESG-based strategies between 2018 and 2020.
According to this report, 79% of asset management firms and companies are already applying these criteria to the way in which they are investing or creating the products or services they market. In the case of 77% of the insurance companies and pension funds that are currently applying ESG criteria, nearly half of these are presently investing 25% or less of their portfolio in specific strategies based on ESG criteria, and plan to increase this percentage to 50% or more over the next two years.
Similarly, in the case of 80% of asset management firms that are already applying ESG factors, 40% of these are currently marketing 25% or less of their funds as ESG-based. However, this figure is expected to increase considerably over the coming years.
In this regard, Felipe Herrera, Vice President of Inversiones de Protección, points out that "ESG-based investments have become far more relevant to asset management over the last few years. According to recent studies, around 71% of individual investors consider that companies applying these criteria shall reap greater benefits".
Consequently, implementing sustainable practices on a corporate level has taken on a crucial importance, especially nowadays when more attractive strategies are needed for investors, given the current global economic and social situation and the uncertainty prevailing on the stock markets. In turn, benchmarks such as S&P, the Dow Jones Indices, MSCI ESG Indices and the FTSE4Good Index track companies that are taking into account ESG criteria.
"The Nordic and Asian markets are good examples of this, in fact the Hong Kong Stock Exchange requires all those companies listed on its Hang Seng Index to publish statistical information regarding their environmental indicators, this going back two years. The Singapore Stock Exchange began to do this same thing not long ago" explains Martín Jiménez, an expert in capital markets and finance from the Universidad Externado de Colombia.
ESG criteria in Latin America
In our own specific region, there is still a way to go with respect to securing the same level of progress as with the more developed countries, as Mr. Herrera is quick to point out.
"The growing importance of ESG investments is still at an incipient stage, contrary to what we have seen in Europe or the United States, where regulations and customer demand have encouraged companies and large-scale asset owners to incorporate ESG factors into their own DNA and report the corresponding information, thereby allowing investors to make more informed decisions. Companies and investors in Latin America are only just beginning to tread the path that developed economies have already taken," added the vice president of Inversiones de Protección.
On the other hand Esteban Botero, vice president of Asset Management de Bancolombia, agrees that investors are increasingly taking into account sustainability criteria, being fully aware of the impact that their resources have on the environment and therefore are more demanding in terms of the risk and impact assessments of their potential investments.
They are also looking for companies that contribute to society and have a positive effect on their environment, while preferring those that offer transparent governance. "By meeting ESG criteria, a company effectively ensures its ongoing sustainability. Also, there is clear evidence that when companies are awarded low ratings for their corporate governance, their credit ratings are lowered soon afterwards. Portfolios for which ESG criteria have been firmly introduced in the corresponding investment evaluations are more profitable in the mid- to long term," stated Mr. Botero.
In this context, investment evaluations over longer time horizons are becoming more demanding and effectively cover material impacts on an investee’s financial statements that could prevent it from meeting obligations with its investors or produce an impairment to the conditions that were initially analyzed.
In fact, over recent years, large-scale publicly traded companies have experienced an impairment to their net worth, as a result of reputational risk events caused in turn by inadequate or improper ESG practices.
"Institutional investors, especially, have begun to take important steps to honor their fiduciary duty, so as to be able to identify early warning signs and avoid making unsustainable long-term investments that could well have a direct effect on their business," concluded Mr. Herrera.
Therefore, one of the biggest challenges in applying ESG criteria is that issuers are not making much information available in this respect, and what they do publish offers low levels of data comparability and, in some cases, is of low quality. That is why we need to standardize the information provided by issuers and help those in charge of evaluating investments to further their knowledge of these matters.