The 2020 pandemic has been an eye-opener for most investors and also financial advisors like me. Just like a healthy life, it made us assess an investment or a company, not only for its financial performance, but also its longevity and sustainability.
However, a lot of investors are still skeptical when it comes to these as the best way to invest to generate a return and I would say rightly so! Conscious investing is a growing trend and the metrics required to judge a company as being ESG compliant are still a little opaque and companies do not always disclose the information needed. Even some funds which are supposed to be ESG compliant have sidestepped requirements, like recently in the case of the BNY Mellon fund.
So the concern over investing in these companies is quite justified. In my opinion, ESG is a fascinating concept and a move in the right direction. It judges companies and investments on different parameters related to Environmental, Social and Governance standards. This makes companies more conscious of how they run their businesses, improve practices and in the long run is expected to offer better value to shareholders & employees by making the world a better place overall.
But in order to maximize gains and gradually incorporate more ESG compliant companies in your portfolio, one needs to do a thorough investigation or consult a financial advisor in UAE.
There are primarily 3 parameters to look at:
Environment: Here, we try to evaluate the overall impact a company has on the environment. Right from the use of toxic chemicals involved in the manufacturing process, the company’s carbon footprint, and sustainability efforts, everything matters. As the global economy including UAE is getting more serious about climate change, investors in Dubai have a lot of options to choose from.
Social: In the end, it’s all about the people and relationships. The “S” in ESG refers to a company’s social impact. Does it work towards making the world a better place for all its stakeholders, which includes employees, consumers, investors, its supply chain and all the people they affect in the process of running a business? Social factors such as racial diversity, inclusion programs, hiring practices, the work-life balance of employees, equal pay, policies, perks etc. are crucial to consider. Socially responsible organizations garner a lot of appreciation from all stakeholders and their employees.
For example, Walmart became a more palatable choice for socially minded investors after it announced in September that it would restrict the types of firearm ammunition that it sells.
Governance: In the context of ESG, governance is mainly how the top management & decision makers of the company run the company. How well do executive management and the board of directors attend to the interests of the company’s various stakeholders – employees, suppliers, shareholders, regulators and customers?
Does the company put profits over everything else? Are they willing to circumvent some rules, cut corners in order to benefit the top and bottom lines, which in return will result in better remuneration for its directors etc. Poor governance practices lead to corporate scandals, which severely affect a brand and its business. Boeing and Volkswagen have learnt the hard way when it comes to such issues, and their stocks were punished in the markets as a result.
Although in UAE, we have had the Shariah compliant investing for a while, which can be treated as a conscious investing guideline, the idea of ESG investing is getting more attention especially from the younger generation. Factually, some recent reports show that 86% of investors in UAE know about conscious investing, 80% have expressed an interest in ESG investing, and 40% who have not yet done ESG investing, plan to do it soon. However, UAE’s adoption rate for conscious investing at 57% is lower than the global average of 61%.
According to a Standard Chartered report, the allocation of ESG investments in investor portfolios has increased in the last few years. 13% of UAE investors already have more than 25% of their total investments channeled into sustainable solutions, compared with just 2% of investors in 2020.
So we can safely say that despite some criticism, there is a slow & steady shift. ESG investing is both “the right thing to do” and an approach to investing that is most likely, over the long term, to provide investors with the best possible risk-adjusted return on investment (ROI).
Let’s look at some of the Advantages of ESG Investing
1. Lower portfolio risk: You pick any industry – environmental, social, and governance issues will have serious risks to operations and profits. When companies comply with ESG norms, they actively work to address the associated risk. Hence, we see fewer business disruptions, and companies produce more reliable financial results. Indirectly, it means lower downside risk for investors.
2. High returns: Reports show that ESG stocks generate comparable or in some cases, better financial results compared with their non-ESG peers. I have seen this play out favorably for quite a lot of my clients here in Dubai.
But like any other investment, ESG also comes with its risks.
Risks associated with ESG investing
1. Lack of universal ESG standards: There are no agreed-upon standards for evaluating companies based on ESG parameters. It creates inconsistencies in ESG portfolios and funds. You may invest in an ESG fund but may figure out later that it does not align with your values.
2. Showing sustainability data is not mandatory: Companies may stop reporting sustainability data while reporting results or otherwise. Hence, you may not know the company’s performance on ESG parameters.
So is ESG investing right for you?
If you are someone looking to include ESG compliant companies in your portfolio, you can start by taking calculated risks & making a gradual shift. You can have a mix of investments that safeguard your financial goals as well as your moral goals. Feel free to contact us for a portfolio evaluation or to know more about conscious investing in Dubai.