Environmental, social and corporate governance

Environmental, social and governance (ESG) refers to the three central factors in measuring the sustainability and ethical impact of an investment in a company or business. These criteria help to better determine the future financial performance of companies (return and risk). Historical decisions of where financial assets would be placed were based on various criteria, financial return being predominant. However, there have always been plenty of other criteria for deciding where to place your money – from Political considerations to Heavenly Reward. It was in the 1950s and 60s that the vast pension funds managed by the Trades Unions recognised the opportunity to affect the wider social environment using their capital assets - in the United States the International Brotherhood of Electrical Workers invested their considerable capital in developing affordable housing projects, whilst the United Mine Workers invested in health facilities. In the 1970s, the worldwide abhorrence of the apartheid regime in South Africa led to one of the most renowned examples of selective disinvestment along ethical lines. As a response to a growing call for sanctions against the regime, the Reverend Leon Sullivan, a board member of General Motors in the United States, drew up a Code of Conduct in 1971 for practising business with South Africa. What became known as the Sullivan Principles attracted a great deal of attention and several reports were commissioned by the government, to examine how many US companies were investing in South African companies that were contravening the Sullivan Code. The conclusions of the reports led to a mass disinvestment by the US from many South African companies. The resulting pressure applied to the South African regime by its business community added great weight to the growing impetus for the system of apartheid to be abandoned. In the 1960s and 1970s, Milton Friedman, in direct response to the prevailing mood of philanthropy argued that social responsibility adversely affects a firm's financial performance and that regulation and interference from 'big government' will always damage the macro economy. His contention that the valuation of a company or asset should be predicated almost exclusively on the pure bottom line (with the costs incurred by social responsibility being deemed non-essential), underwrote the belief prevalent for most of the 20th century. Towards the end of the century however a contrary theory began to gain ground. In 1988 James S. Coleman wrote an article in the American Journal of Sociology entitled Social Capital in the Creation of Human Capital, the article challenged the dominance of the concept of ‘self-interest’ in economics and introduced the concept of social capital into the measurement of value. There was a new form of pressure applied, acting in a coalition with environmental groups: it used the leveraging power of its collective investors to encourage companies and capital markets to incorporate environmental and social challenges into their day-to-day decision-making. The Ceres coalition today represents one of the world's strongest investment groups with over 60 institutional investors from the U.S. and Europe managing over $4 trillion in assets. Although the concept of selective investment was not a new one, with the demand side of the investment market having a long history of those wishing to control the effects of their investments, what began to develop at the turn of the 21st century was a response from the supply-side of the equation. The investment market began to pick up on the growing need for products geared towards what was becoming known as the Responsible Investor. In 1998 John Elkington, co-founder of the business consultancy SustainAbility, published Cannibals with Forks: the Triple Bottom Line of 21st Century Business in which he identified the newly emerging cluster of non financial considerations which should be included in the factors determining a company or equity's value. He coined the phrase the 'triple bottom line', referring to the financial, environmental and social factors included in the new calculation. At the same time the strict division between the environmental sector and the financial sector began to break down. In the City of London in 2002, Chris Yates-Smith, a member of the international panel chosen to oversee the technical construction, accreditation and distribution of the Organic Production Standard and founder of one of the City of London's leading branding consultancies, established one of the first environmental finance research groups. The informal group of financial leaders, city lawyers and environmental stewardship NGOs became known as The Virtuous Circle, and its brief was to examine the nature of the correlation between environmental and social standards and financial performance. Several of the world's big banks and investment houses began to respond to the growing interest in the ESG investment market with the provision of sell-side services; among the first were the Brazilian bank Unibanco, and Mike Tyrell's Jupiter Fund in London, which used ESG based research to provide both HSBC and Citicorp with selective investment services in 2001. In the early years of the new millennium, the major part of the investment market still accepted the historical assumption that ethically directed investments were by their nature likely to reduce financial return. Philanthropy was not known to be a highly profitable business, and Friedman had provided a widely accepted academic basis for the argument that the costs of behaving in an ethically responsible manner would outweigh the benefits. However, the assumptions were beginning to be fundamentally challenged. In 1998 two journalists Robert Levering and Milton Moskowitz had brought out the Fortune 100 Best Companies to Work For, initially a listing in the magazine Fortune, then a book compiling a list of the best-practicing companies in the United States with regard to corporate social responsibility and how their financial performance fared as a result. Of the three areas of concern that ESG represented, the environmental and social had received most of the public and media attention, not least because of the growing fears concerning climate change. Moskowitz brought the spotlight onto the corporate governance aspect of responsible investment. His analysis concerned how the companies were managed, what the stockholder relationships were and how the employees were treated. He argued that improving corporate governance procedures did not damage financial performance; on the contrary it maximised productivity, ensured corporate efficiency and led to the sourcing and utilising of superior management talents. In the early 2000s, the success of Moskowitz's list and its impact on companies' ease of recruitment and brand reputation began to challenge the historical assumptions regarding the financial effect of ESG factors. In 2011, Alex Edmans, a finance professor at Wharton, published a paper in the Journal of Financial Economics showing that the 100 Best Companies to Work For outperformed their peers in terms of stock returns by 2-3% a year over 1984-2009, and delivered earnings that systematically exceeded analyst expectations.