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Expert Opinions: The rise of Environmental, Social, and Corporate Governance

By Jamie Boyle

ST. PETERSBURG (April 8, 2021) -- Environmental, Social, and Corporate Governance (ESG) or sustainable investing/socially responsible investing has grown dramatically in recent years. Is this a trend? What impact will it have on the investing world? We turned to experts Professor Tina Yang and John Fodor, retired executive vice president of Global Distribution, The Capital Group/American Funds for their thoughts.

It seems as though more companies are starting to focus on ESG now more than ever, why is that? Fodor explains that it is simply smart business.

“Success leads to success,” he said. “There has been a lot of work and research done on ESG measurements that have shown that companies that score well in their ESG scoring have outperformed others.”

ESG used to be seen as “nice to do,” but it has quickly become “need to do.”

Yang gave us another reason for the rise in ESG, stating, “Firms are starting to focus more on ESG because of the demand. Consumers want to buy products from sustainable companies; investors are interested in holding stocks of sustainable companies. Additionally, firms start to find ways to use ESG to their advantages.

“For example, if consumers value the ESG activities of a firm, they are more willing to pay higher prices for the firm’s products,” she said. “As another example, if a bad piece of news hits the firm with a high ESG score, investors are less likely to sell the stock because they believe the firm will fix the problem properly and in time.”

ESG companies are seeing great success in terms of profitability and financial performance.

Fodor sees the success of ESG as a direct result of the competent management of these companies.

“Well-managed companies historically have outperformed lesser managed companies,” he said. “It happens to be ESG related, but environmental, social, and governance, risks, and opportunities that are results from that, to me is just common, really solid business practice, it’s intuitive and the proxy happens to be ESG.”

Both Fodor and Yang do not think ESG practice is going anywhere, it will continue to grow and become standard practice of the future.

“I believe that this is the future of investment because of a confluence of factors,” Yang said. “For example, younger investors have become increasingly interested in ESG. A CFA survey finds that in 2020, 56 percent of investors 65 years and older are interested in ESG, compared to 75 percent for the 25-34 age cohort.

“Historically, firms have typically viewed environmental issues as beyond the domain of corporate activities,” she said. “Science regarding the impact of climate risk has become more widely understood. Regulators and the capital market have begun imposing costs as well as providing incentives for firms to act upon environmental issues.”

Fodor believes that ESG should and will become the future and that ESG is becoming a real investment and management discipline. “If that means that we are then paying more attention to environmental issues and doing so in a way that’s practical, we are paying more attention to social issues, diversity, equity and inclusion, around security and data privacy, around human capital development,” he said. “And hey, if we’re having more ethical discussions at the board level about how important ethics are in running a company, maybe that leads to people not doing so many self-centered-things, that would be so cool.”

Fodor believes that if ESG can be the vehicle in which we get there, then we should all get involved.

Barron’s 2021 list of 100 Most Sustainable Companies ranks Best Buy as No. 1. How is such a traditional company like Best Buy ranked at the top for sustainability? Fodor explains that this is because ESG looks different in every industry. SASB (Sustainability Accounting Standards Board) is a board that has established industry criteria and every industry has different factors that classify them under different components of ESG.

“It is not surprising to me to see a Best Buy or others that you may not think of, because within their industry sector, their material ESG factors are unique to that industry or company,” said Fodor.

What if any risks come with ESG?

“One criticism against ESG is that managers may be inclined to use other people’s money—investors’ money—to buy ‘personal glory’ (e.g., invest in charities or causes managers, but not society, are passionate about)” said Yang. “Another concern is green washing. Namely, some firms talk a good talk but do not do any meaningful ESG. Adding to this concern is that we have six main ESG ratings. The correlation between these ratings ranges from 0.38 to 0.71 (Berg, Koelbel, and Rigobon, 2020).

“Lastly, ESG is culture dependent,” she said. “A practice considered bad in one culture can be viewed as the norm in another culture. Therefore, it can be very difficult for consumers and investors to effectively apply ESG criteria to screen and award firms.”

Although Fodor is a strong advocate for ESG, he does feel that if it were to become overregulated it could lose its meaning. ESG has grown very organically up until this point and has been successful in that way, but if regulations were to become too onerous or ESG became simply a “check the box” compliance effort then the true material benefits of ESG would be lost. 

Fodor retired six years ago, but in the past several years his former company has hired more than 25 people specifically for ESG.

“So many jobs of the future are going to focus on ESG investing, rankings, reporting and many companies themselves are looking to solve these ESG issues like environmental,” Fodor said. He sees more companies and higher education programs gearing interest towards ESG as these standards continue to gain prominence.