Socially responsible investing has become increasingly popular among investors. It represents one third of global assets. But don't investors have to settle for lower yield? What determines which companies meet ESG (environmental, social and governance) criteria and which do not? Janka Ružická, Sustainability Director at Mazars, answered these questions for Forbes.
This article, originally in Slovak language, has been written by Forbes' journalist Peter Apolen. Access the original version of the interview here.
Do investors who want to invest in a socially responsible way have to give up yield?
Today, it seems that the responsible investing trend is not only “fashionable" but also financially sound for investors. This summer, for example, S&P Global disclosed that as many as 16 of the 27 ESG funds they analysed outperformed the S&P 500 Index in the first few months of this year. A larger study that analysed the entire pandemic year showed that 19 of the 26 ESG funds outperformed the S&P 500 index. This means that it is not true that ESG funds are less profitable.
For whom ESG investments are attractive
How has the ESG investment trend been evolving? Which investors are focusing on it?
As far as individuals are concerned, ESG investments are particularly attractive to younger people. This generation wants to invest money in a sustainable way, and they want it to be used to fund projects and companies with a positive impact on the environment.
The customer has changed, so the offer has changed as well. Gradually, traditional investors will leave the market and focusing exclusively on financial yield will cease to be interesting. I believe that sustainable and responsible investing will gradually become mainstream.
Has the pandemic played a role in this?
Yes, it has. The presence of the coronavirus is directly related to the loss of biodiversity. While many animal species are dying out, rats and bats, which are more likely to host pathogens dangerous to humans, are thriving. Scientists have been pointing this out for a long time.
There is a direct link between current trends - increased global demand for meat, deforestation and the consequent loss of biodiversity, and the spread of new diseases of zoonotic origin.
I think this pandemic experience is a warning. The situation has further stressed the fact that the economy and the state of the environment are intertwined, even if some people had tried to turn a blind eye and operate in old ways.
What do we mean by responsible investing?
Sustainable and Responsible Investing (SRI) is a long-term oriented investment approach that integrates ESG factors into the process of selecting securities for an investment portfolio. There are funds that exclude, for example, the tobacco industry or the arms industry or high-risk countries and so on.
Some funds use an active ownership strategy. I used to work in the past as an analyst for this category of funds. In these, the shareholder influenced ESG strategy through voting and dialogue with representatives of the company that they invested in.
Another type of fund is a thematic fund, which invests in companies that are working to solve specific social or environmental problems. For example, we had an investment fund focused on peacebuilding. It evaluated how the companies that were in the fund were contributing to stability and peace in war-torn economies through their business.
What sustainability criteria must be met by companies that are included in an ESG fund's portfolio?
In most cases, the areas that are most risky for the sector in which the firms operate are examined. For example, insurance companies are assessed on how resilient they are to climate change, how they manage customer data protection and privacy, etc.
For companies that have a complex and large supply chain, it is assessed whether the company conducts environmental and social supplier audits, what the content and results are, how problems with suppliers are solved, and whether and how they educate their suppliers on sustainability.
Sustainability should not just be a PR activity
Is the extent to which the company has incorporated social responsibility into its corporate culture also part of the assessment?
Yes, it is assessed how ESG is integrated into the business strategy, whether ESG targets are linked to turnover: i.e., whether the company sets a target of what percentage of turnover must be generated from green or sustainable products.
The assessment can also focus on whether top management remuneration is linked to the firm's environmental and social performance, not just financial performance, and who is in charge of this area in the company.
Of course, a company where a PR assistant is in charge of this broad agenda has a much lower rating from its investor than a company where a strong ESG governance structure is in place and directly accountable to the company's board of directors.
The ESG trend only started to become a public topic in recent years, but it has been around for a very long time. Have these criteria changed in time?
Yes, the criteria are changing, and new ones are being added. For example, three years ago, the fund I worked for started assessing tax transparency in companies included in the portfolio.
This year, this parameter also appeared in the European Parliament, and multinationals will be obliged to publicly declare the amount of taxes they pay in each EU country when they exceed a certain turnover threshold. Overall, my impression is that the standard is moving from voluntary to statutory obligations.
Which authorities grant or confirm this status?
A company that has been included in the investment portfolio of an ESG fund has mostly already been "reviewed" by a number of institutions or rating agencies.
Where does ESG information on companies come from and is this information credible?
Earlier this year, the EU drafted a directive requiring companies to report information on the sustainability of their business. Reporting for 2023 will be mandatory for companies that meet at least two of three criteria: having more than 250 employees, a balance sheet of more than €40 million and a turnover of more than €20 million. Smaller companies will not escape it either, but they will have the obligation delayed by three years.
I believe this is a positive step. It is good for investors, the public and the companies themselves. The annual sustainability report is like an X-ray. It will display both strong and weak points.
According to our analyses, approximately 30 Slovak companies currently have experience with the so-called sustainability business card. The more stringent reporting criteria would be met by no more than a third of them.
I will give an example. A company declares on its website that it adheres to the principles of the United Nations Global Compact (UNGC). The UNGC requires companies to provide detailed information on their compliance with these principles. In Slovakia, for example, there were five companies that were signatories to this agreement in the past. However, on the UNGC website, their status in their profile is 'delisted'.
This is because they do not provide enough information. Either they don't have the ESG information complete, or they don't want to disclose it, or they don't have the time, have forgotten, or no longer want to follow the principles.
This applies to all standards. So, a company can declare that it is applying them, but the organisation itself will check and 'grade' its efforts. UNGC gives its signatories a label: delisted, active or advanced.
A scorecard for companies
Such failure to disclose information can therefore have a negative impact on the company...
Figuratively and simplistically, we can say that when a company gets a lot of poor “grades” from several leading global institutions and flops, it ceases to be interesting for investors.
Even in the ESG fund I worked for, there were occasionally financially successful companies for a year or two, but they were dropped from the portfolio because we didn't have information about them, and they weren't using global benchmarks. So, they didn't have a “scorecard" and they didn't communicate with investors.
Read the article on Forbes
Jana Ružická Sustainability Director at Mazars in Slovakia
In 2004, she started her career at the Pontis Foundation and co-founded the Slovak Business Leaders Forum. She worked for seven years as an analyst for several ESG funds of the investment firm de Pury Pictet Turrettini. As a consultant, during her tenure at Denkstatt in Austria, BHP Brugger and Partners in Switzerland and Foundation Guile, she has advised and trained more than 500 companies on corporate responsibility. Jana Ružická Sustainability Director