Much of the pushback against integrating ESG into investing states that ESG and financial concerns are separate. Such claims are uninformed and misguided.
Incorporating sustainability into the investment process relates to things like cost-savings, consumer loyalty, and identifying vulnerabilities to costly scandals.
Ignoring ESG factors can harm shareholders because that mindset can lead companies to lose market share and miss out on new opportunities for growth.
The negative press directed toward environmental, social and governance (ESG) investing is creating much confusion. The common theme underlying this criticism and occasional hostility is that paying attention to ESG issues ignores, or even damages, financial returns. In our view, this is not the case – it is the opposite of what “sustainability” means.
We think it’s time to remember the basics of sustainable investing. With exceptions such as impact funds that invest capital in pursuing specific objectives or funds that screen out certain industries, we believe integrating ESG into the investment process is about analyzing issues that may affect firms’ financial risks and economic sustainability. Said another way, ESG integration is process-oriented and sustainable strategies are outcome-oriented.
The current pushback against ESG is also generating a lot of noise and distraction. That could make it harder to focus on legitimate economic reasons to integrate this analysis into investing and corporate decision-making. We believe 10 of these economically legitimate and compelling reasons include:
1. Climate Change Directly Impacts Global Economics
The economic impact of climate change is making recent headlines, such as “Droughts Take Widening Toll on World’s Largest Economies” in the Wall Street Journal. The destruction caused by extreme weather hits consumers in their wallets and insurance companies in their reserves.
Virtually every climate risk model says we can expect more frequent Category 4+ hurricanes. Hurricane Ian’s damages, estimated at $70 billion, are roughly equal to IBM’s revenues for 2021 and Target Corp.’s entire market cap. If we don’t reach the targets intended to slow global warming by mid-century, insurance giant Swiss Re estimates that the world could lose around 10% of its total economic value from climate change.¹
2. Diversity Improves Business Outcomes
Pursuing diversity in the workplace, including the board of directors, C-suite and the general workforce, improves business outcomes. Study after study shows that diverse groups of people make better decisions than homogeneous groups — decisions about product lines, manufacturing, logistics, marketing and everything else that directly or indirectly affects sales and profits.
Google’s research team found that consumers are more likely to at least consider and maybe buy a product after seeing an ad they deem diverse or inclusive. Some 64% of those surveyed said they “took some sort of action after seeing an ad that they considered to be diverse or inclusive.”²
3. Stronger Corporate Governance Saves Money
Companies end up paying out millions (sometimes billions) of dollars due to poor governance. This includes the cost of litigation arising from breakdowns in quality control and failures to enforce anti-harassment policies that prompt employees to quit and sue the company. More robust corporate governance could prevent many of these unforced errors, saving that money for the company and its shareholders.
4. Engaged Employees Don’t Quit
Striving to keep employees engaged at work makes economic sense because when people don’t like their jobs, they often quit. Recruiting and training are expensive. Executives consistently say that finding and retaining talent is one of their biggest challenges.
It’s more cost-effective to improve employee engagement than to use resources fighting constant battles against high levels of turnover. Estimates show that U.S. businesses lose a trillion dollars annually from employee turnover, which is mostly avoidable.³
5. Reducing Waste Reduces Costs
Recycling, upcycling and reducing waste in the workplace and product packaging makes economic sense because it reduces costs, improves brand image and increases customer loyalty. Over 75% of consumers across 18 countries in North America, Europe and Latin America who are influenced by sustainability when buying food products say they expect companies to invest in sustainability.⁴
6. Greenhouse Gas Emissions Hurt Consumer Spending
Greenhouse gas effects are intensifying droughts and floods that destroy crops. Droughts are forcing many farmers to stop planting crops they have grown for decades. This pushes up food prices, fueling inflation, hurting consumers and reducing income in local communities. The impact trickles down throughout the economy because spending more on food means spending less on other goods and services.
7. “Green” Design Principles Decrease Maintenance Costs
Office buildings, hotels and other commercial facilities built using green design principles and eco-friendly materials save money by reducing energy use, consuming less water and managing waste more efficiently, thereby lowering maintenance costs. These properties tend to attract prime tenants who provide stable revenues. Green hotels appeal to eco-conscious travelers.
8. Food Waste Impacts Industry Profits
Wasting food is bad for food industry profits. A 2019 study from the University of California, Davis estimates that 1.3 billion metric tons of food are wasted annually worldwide, including 30 million tons in the U.S. That means roughly one-third of all food produced globally is wasted. In developed countries, about 20% of food is wasted on farms due to improper or inadequate drying, storage, packaging and transportation. The international coalition Champions 12.3 found that for every $1 invested in reducing food waste and loss, companies save $14 in operating costs.⁵
9. Access to Financial Services Helps Developing Countries Thrive
Providing easier, affordable access to financial services to low-income populations in developing countries boosts economic growth. Microbusinesses that accept and make payments digitally can better satisfy customers and suppliers and keep their money secure. This helps them thrive, benefiting everyone, including companies in developed countries that supply these markets.
10. A Green Energy Economy Will Create New Jobs
Transitioning to a clean energy world will undoubtedly cause disruptions in fossil fuel industries, and we should not be dismissive of the impact on jobs in the short term. But that doesn’t mean we should try to preserve the status quo! This is the story of economic evolution over time (recall that the Industrial Revolution upended labor markets). Green energy and job growth can go hand in hand.
Moving to green energy is expected to create 10.3 million new jobs globally by 2030, far exceeding the 2.7 million jobs expected to be lost in the process. And while we believe it’s prudent to continue to use fossil fuels as part of a just transition to a clean energy world, given that solar and wind power now cost the same or less than fossil fuel, it makes economic sense to keep shifting toward renewables.⁶
Why Is ESG Important?
In our view, ESG integration and sustainable investing are about identifying business risks and opportunities related to environmental, social and governance issues that don’t show up on financial statements.
It’s about using this information to invest wisely so that we can earn competitive returns for our shareholders. ESG integration is value-creating investing, not values-based investing.
1Swiss Re Institute, “The economics of climate change,” April 22, 2021.
2Shelley Zalis, “Inclusive ads are affecting consumer behavior, according to new research,” Think with Google, November 2019.
3Shane McFeely and Ben Wigert, “This Fixable Problem Costs U.S. Businesses $1 Trillion,” Gallup, March 13, 2019.
4Kerry, “Sustainability in Motion: Actioning Consumers’ Sustainability Goals,” August 2021.
5Champions 12.3, “The Business Case for Reducing Food Loss and Waste,” March 2017.
6Omri Wallach, “How many jobs could the clean energy transition create?” World Economic Forum, March 25, 2022.
References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
Sustainability focuses on meeting the needs of the present without compromising the ability of future generations to meet their needs. There are many different approaches to Sustainability, with motives varying from positive societal impact, to wanting to achieve competitive financial results, or both. Methods of sustainable investing include active share ownership, integration of ESG factors, thematic investing, impact investing and exclusion among others.
Many of American Century’s investment strategies incorporate the consideration of environmental, social, and/or governance (ESG) factors into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider ESG factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh ESG considerations when making decisions for the portfolio. The consideration of ESG factors may limit the investment opportunities available to a portfolio, and the portfolio may perform differently than those that do not incorporate ESG considerations. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.
ESG Integrated: An investment strategy that integrates ESG factors aims to make investment decisions through the analysis of ESG factors alongside other financial variables in an effort to deliver superior, long-term, risk-adjusted returns. Therefore, ESG factors may limit the investment opportunities available, and the portfolio may perform differently than those that do not incorporate ESG factors. Portfolio managers have ultimate discretion in how ESG issues may impact a portfolio’s holdings, and depending on their analysis, investment decisions may not be affected by ESG factors.
ESG Focused: An investment strategy that focuses on ESG factors seeks to invest, under normal market conditions, in securities that meet certain ESG criteria or standards in an effort to promote sustainable characteristics, in addition to seeking superior, long-term, risk-adjusted returns. This investment focus may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have an ESG investment focus. ESG-focused investment strategies include but are not limited to impact, best-in-class, positive screening, exclusionary, and thematic approaches.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments’ portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.