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Forever blowing bubbles?

Strangely, this is not a piece about melting permafrost and the ever-present emissions risk of climate-wrecking methane. No, it’s about the existential matter of ESG.

With fast growing markets, concepts and products the inherent danger is always that the trends are just a ‘bubble’ that will eventually burst, with devastating consequences. So, when the demand and interest in a market significantly increases, cynics are quick to classify the trend as merely another bubble that is destined to burst. Since the early stages of ESG and responsible investment first started taking shape (UN Who Cares Wins report 2006), it usage has grown rapidly; a survey by the Global Impact Investing Network shows that the number of managers offering ESG strategies has grown by 400% over the last few decades. This substantial increase in use and coverage of ESG inevitably begs the question, is ESG just another global bubble, or is it in fact here to stay?

There are a number of fundamental factors that indicate that ESG is not just a ‘bubble’ but is a reflection of the change in attitudes towards sustainability and corporate thinking and is a long-term solution to aid global development. Let’s step inside the bubble…

Firstly, the impacts of climate change are on our doorstep and are no longer a problem for distant populations to deal with. Climate change impacts will be so vast and significant that they have the power to completely change attitudes and mechanics of the global economy. Indeed, this change is already taking place- the Paris agreement (2015), demonstrated an almost universal recognition that collective action must be taken in order to reduce the impacts of climate change. Long term government policies, strategies and legislation that have emerged from this realisation, will mean that companies and investors will have to adhere to certain standards of practice (e.g. limit their adverse environmental impacts) and ensure compliance to new regulatory measures. Emissions restrictions and carbon tax are just a few policies that could come into place that will shape the investment risks for the future. Almost 500 companies are already proactively aligning their corporate strategy with government policy through committing to set science-based targets for emissions to stay within the 2°C warming target agreed at Paris.  ESG will be integral for accompanying these measures and ensuring their effectiveness. The immediacy of climate change means that failing to account for its impacts on the markets will be a huge investment risk in both the short and long term.

More generally, the global financial crash of 2008, triggered a change in attitude towards business and investment. Investors and business leaders were made brutally aware of the severity of the consequences of irresponsible practices and were forced to rethink investment, looking towards long term sustainable practices. Ten years on from the crash and research suggests that 40% of asset owners now consider ESG risks in investment decisions. The current and future generations of investors have been moulded in part by the 2008 crash and thus see ESG as an essential decision making tool. Around 70% of high net worth investors from the so called ‘Millennial’ generation expect their wealth managers to screen for ESG factors. This generational switch in values, intensifies to the momentum of the paradigm shift towards sustainable investment and away from the old market model.

However, this trend is not purely a reactionary response to the 2008 crash. The changing trend of investment and market is much deeper and has existed for decades. The following graph shows how the principle value of business has transitioned from tangible assets to intangible assets. More importance is being placed on the intangible measures of business, incorporating a lot of ESG factors- governance strategies, reputation, innovation and so on. These attitude changes to responsible investment seem to indicate that ESG is not just a ‘bubble’ but is, thankfully, here to stay.

Components of S&P500 companies- % tangible assets vs intangible assets

Source

The evolution of ESG now and in the future must continue to adapt and develop. As ESG becomes increasingly sticky in the mainstream corporate sphere, its identity is moving away from just a ‘hippy’ concept and instead is taking on a fundamental role in corporate and financial strategy. A Darwinian analogy might suggest that as ESG continues to be successful and compete, its place within the corporate ‘gene pool’ will strengthen. Sustained ESG success will result in a ‘hybridisation’ of ESG DNA with corporate DNA, cementing ESG as an integral part in the evolution of business strategy going forward. Those that embrace ESG into their corporate DNA will evolve and compete and those that stick to old ways will be at risk of extinction.

Bye bye dinosaurs…

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