The turbulent events of year 2020 have fundamentally changed the way many people see the world. They have stirred up a growing desire for change and for action to tackle the burning issues confronting us, such as climate change, inequality, and injustice.

Global cross-sector cooperation will be vital in efforts to manifest the mantra of “building back better.” Ethical investing will surely play a pivotal role in propelling the movement as investing in companies with robust environmental, social, and governance (ESG) practices is no longer a passing fad but part of a broader trend to contribute to a better world. 

Companies leading in ESG often benefit from enhanced corporate reputation, improved operational efficiencies and better risk management, as well as increased opportunities for growth and innovation. Based on the record so far, it is also an approach that pays dividends.

While the concept of ESG should be integrated into all sectors of business, the question for ESG-focused investors often lies in how to avoid greenwashing and identifying sectors and companies to invest in that are doing well in balancing stakeholder interests and profitability. Here are some of the trends in ESG investment to watch out for:

Good governance spells resilience in uncertain times

When we speak of sustainability, we speak of the future. With the global COVID-19 outbreak bringing daily life to a halt in cities and businesses across the world, it is hard to predict what the future holds. 

However, fund manager Fidelity International has found a strong positive correlation between a company’s relative market performance and its ESG rating in the first nine months of 2020. Meanwhile, companies with higher governance scores also performed better than their peers globally, as demonstrated by a 4.3% outperformance by the MSCI World Governance-Quality Index against the MSCI All Country World Index (MSCI ACWI) in 2020. 

This may suggest investors have been placing their chips on companies that demonstrate strong ESG awareness, as that characteristic often signifies a company’s ability to be forward-looking and strategic-minded when assessing different scenarios material to their business. 

An agility to adapt at times of crisis also implies good governance practices which allow optimal resource utilisation, as well as better technical and digital capabilities to maintain business as usual. Investors are scrutinising companies’ response to COVID-19 and will reward companies that show strong resilience and prioritise quality ESG commitments, while shunning those that create negative impacts and risk quality growth for short-term profit.

Climate change remains the weathervane

Climate change is likely to dominate the ESG arena for years to come as governments around the world introduce more climate-related regulations. Recognising the important role of investors in driving climate action, major financial institutions have also made shifts towards ESG strategies. Goldman Sachs, for example, has announced to stop financing Arctic oil drilling while BlackRock has made a pledge to Climate Action 100+. 

Furthermore, climate disclosure systems including the CDP are increasingly being adopted to help companies manage their environmental impacts, with some jurisdictions also requiring mandatory disclosures like the Task Force on Climate-related Financial Disclosures and the Stock Exchange of Hong Kong’s ESG Reporting Guide. To help generate better alignment and comparability of ESG and financial data for investors to benchmark sustainable business practice, focus is growing on the harmonisation of international sustainability standards and frameworks such as the one being developed by the International Financial Reporting Standards (IFRS) Foundation. Corporate climate action benchmarks including the Transition Pathway Initiative are being set in place to support companies in accelerating their transition to a low-carbon economy.

Meanwhile, as lucrative opportunities are emerging in the climate solutions market, an MSCI study suggests climate change innovation in the coming years may be driven by larger and more established players with bigger research and development budgets rather than start-ups. Investors will need to utilise alternative data to spot these companies that are plotting to take the lead in driving climate solutions.

Millennial investors drive change

While ESG investing is a multi-generational conversation, younger generation investors including the millennials are the driving forces for sustainable finance, according to a 2019 Morgan Stanley Institute for Sustainable Investing survey which found that a staggering 95% of millennials were interested in sustainable investing. 

Threats like climate change and COVID-19 do not respect borders and remind us that businesses need to be part of something bigger. With millennials accounting for about a quarter of the global population and a massive, multi-trillion-dollar intergenerational wealth transfer going on from baby boomers to their more ESG-minded children, money is increasingly being channelled toward companies that are good global citizens that prioritise integrity-based business ethics and hold strong track records for delivering consistent business growth through reliable governance. 

Rise of stakeholder capitalism 

Businesses are increasingly declaring that they are committed to serving interests beyond those of their shareholders. This is because customers, suppliers, employees, investors, and communities are exerting greater pressure on companies through their consumption choices and preferences for the kind of companies they want to be associated with.

Companies that have strong ESG practices that benefit all stakeholders are generally less susceptible to lawsuits, labour disputes, or major environmental incidents that could harm their reputation and economic results. For this reason, investors should increasingly focus on social metrics and look into companies that expand ESG monitoring to the supply chain level.