We can all agree that finance plays a key role in achieving net zero. But we cannot ignore the elephant within the room: the inherent conflict between the “E,” the “S,” and the “G” in environmental, social, and governance (ESG) investing.
As much as we might need it, the goals embodied in these initials don’t at all times coincide. Therefore a compromise should be made. Investors, asset managers and firms must agree on which of the three points is most vital.
So where is our position? SustainFinance? We consider that social, the “S,” needs to be a top priority. Why? Because sustainability is all about humanity.
The “S” factor is broad. It varies depending on the country, culture and context. It should be left to people to work out reconcile these inside the confines of net zero targets.
Ultimately, someone has to pay.
Convincing manufacturers with tight margins to spend money to cut back their greenhouse gas emissions is a large challenge. It has consequences.
Let’s make it real: A healthy environment, a living wage and robust employee rights cost money. Customers want these results, but at an inexpensive price. The same applies to investors too. They want their money to go to good corporations that treat their staff well. And they need good investment returns. But ultimately, none of that is free.
To reduce emissions, corporations can have to forego the profits they pay out to shareholders as dividends. At least initially. And with falling dividends comes falling share prices, each of which hurt the returns of those saving for retirement or their kid’s education.
This implies that we have now to balance multiple interests. When it involves investors, asset managers and firms, the whole lot ultimately revolves around people. Therefore, we want to maneuver our pondering away from environmental issues in isolation and towards a more holistic approach that appears at outcomes from a broad social perspective.
In a post-pandemic world, this reset has enormous implications.
Investors want returns.
When it involves future liabilities – retirement, education, etc. – investors are under pressure to attain their required returns.
Their focus is generally on accumulation or income generation. This determines the costs of the assets you might be on the lookout for. Those on the lookout for income to fund their retirement will chase corporations that pay high dividends, especially in the present low rate of interest environment.
In Asia, many corporations pay out a big portion of their profits as dividends. If they cut their profits and subsequently their dividend payments with a view to put money into greening their corporations, the market will punish them. Investors who concentrate on income stocks will put their money elsewhere.
Part of the sustainability challenge is that the businesses with the best dividends are sometimes in traditional, asset-intensive industries with large carbon footprints. To support them of their transition to net zero, investors must accept lower dividend payouts, otherwise these corporations won’t survive the transition to low-carbon alternatives. While this green transition is desirable in the long run, within the short term it can result in uncontrollable economic dislocation.
The biggest challenge facing the asset management industry is the saturated and highly competitive market through which it operates.
Fund managers are traditionally judged on their performance. However, their ability to handle ESG aspects is now one other area of competitive pressure. How can they maintain performance while meeting ESG expectations?
Yes, ESG strategies outperformed in 2020, showing that sustainability can generate returns. However, upon closer inspection, the information suggests that positively screened ESG corporations have lower worker metrics and are likely to be asset-light industries. Automation doesn’t create jobs and technical employees don’t need the identical protection as those on the assembly line.
Investing in large ESG-positive corporations also has a destructive effect. It diverts money from asset-intensive and job-creating industries that support local communities. And what about small and medium-sized enterprises (SMEs) that perform poorly on ESG and wish to finance their transition to net zero? Does the market punish or help them?
Companies are finished.
Companies should walk a high quality line. They must keep their company profitable within the short term while investing in long-term environmental policy. Sustainability isn’t any longer a pleasant accessory, but a method to future-proof your organization.
But keeping to the “E” is pricey. If the prices can’t be passed on to the tip customer, they need to be financed from inside the company, be it in the shape of staff salaries, bonuses or the variety of employees. It may also cause certain functions – and jobs – to turn out to be obsolete. The “E” comes on the expense of the “S”.
In Asia it was once about squeezing every last profit out of the business. Now it’s slowly shifting to longevity and legacy. Paying out all profits in the shape of dividends is short-sighted, while a long-term strategy can increase margins over time. To achieve this, corporations need the best investors.
What’s next?
Stakeholders have to move away from the quarterly mindset and construct longer-term relationships and expectations. You have to say goodbye to get-rich-quick investments.
It takes time to generate returns and stay true to the “S.” Short-termism is the other of sustainable growth. For corporations to fulfill the web zero challenge, they need investors who understand what’s at stake and what it can take to attain it.
Now is the time to acknowledge the elephant within the room and begin changing the mindset. And meaning embracing the S in ESG.
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Photo credit: ©Getty Images / tiero
