Our Q4 2023 Impact Digest is a roundup of important impact investing news as we head toward year-end. In general, we are seeing increasing calls for more stringent and standardized reporting requirements around ESG criteria, and we continue to see evidence of why. Investors, individual and institutional alike, find it challenging to track down accurate, easily comparable data on companies and funds. Without strict, uniform reporting requirements, industry players like ratings analysts and fund managers have a more difficult time accurately assessing ESG-related risk and opportunity. Progress is being made, however, as new regulations are put into place in influential markets like the European Union and California, which can spur action in other areas.
The push for these regulations is more understandable than ever as we continue to be reminded of the relevance of ESG considerations to investment performance, and as investors generally ignore anti-ESG talking points and maintain their commitments. Whether in assessing risk posed by issues like climate change or supply chain instability, or understanding the opportunities presented by companies with strong ESG performance, it is difficult to ignore the evidence that impact investing can provide ways to avoid risk and take advantage of opportunities that might otherwise be missed.
Here are the highlights:
There is mounting concern that credit rating analysts in the $133 trillion global bond market are misreading climate risks, to the detriment of creditors and borrowers. Research by the European Central Bank shows that even when climate variables are statistically significant, they play a marginal role in influencing sovereign ratings. When the Institute for Energy Economics and Financial Analysis looked at Moody’s ESG credit scores for 721 companies in high-emitting industries, it found that about 60% of issuers with high credit ratings were highly exposed to environmental risks, including climate change.
Supply-Chain Sustainability Benefits Investors, Study Finds
WALL STREET JOURNAL
Recent research from Northwestern University and the University of Hong Kong looked at U.S. publicly traded companies and their supply chains and found large-scale evidence of a link between the ESG risk in a company’s supply chain and that company’s future stock returns. Specifically, companies using more responsible suppliers relative to peers—meaning the suppliers had fewer negative ESG incidents—generated higher stock returns in the subsequent year than companies with more ESG risk in their supply chains. A portfolio taking a long position in firms with the fewest supplier ESG incidents and a short position in firms with the most incidents generated an excess return of 6.77% annually relative to its benchmark.
A new California law, the Climate Corporate Data Accountability Act, would force many of the world’s biggest publicly traded corporations to make their carbon emissions public and to report on related vulnerabilities in terms of workforce, supply chains, consumer demand and shareholder value, among other risks. The proposed measure is more expansive than the SEC proposal and would affect private and public companies doing business in the state—5,300 companies that generate at least $1 billion of annual revenue.
According to a new report from Kroll, a financial advisory focusing on governance, risk and transparency, companies with higher ESG ratings “generally outperformed” those with lower ratings during the nine-year period ended December 31, 2021. In its study, Kroll examined more than 13,000 companies across a variety of geographies and industries around the globe. Globally, so-called ESG Leaders generated an average annual return of 12.9% in the nine-year stretch, compared with 8.6% for so-called Laggard companies, according to the report. In the U.S., the country with the largest number of ESG rated companies, the ESG Leaders earned an average annual return of 20.3%, compared with 13.9% for Laggard companies. Researchers acknowledge the “politicization” of ESG, but they conclude that investing simply involves considering “risks and opportunities” and that includes issues that may arise from various ESG trends.
California Senate Bill 54 was signed into law, requiring venture capital firms in the state to annually report on the diversity of the founders they are backing. This is the first piece of U.S. legislation that aims to increase diversity within the venture capital landscape. The law will go into effect on March 1, 2025. Once the law goes into effect, any venture capital firm operating in the state, which includes VC firms headquartered in California, have operations in the state, have invested in companies that operate in or are based in the state, or have received investments from California residents, must report, among other data, the race of the people they back, as well as their disability status and whether they’re a member of the LGBTQ+ community. Disclosing information is voluntary for companies receiving VC funding and founding teams will not be penalized for not answering. The bill also requires firms to collect and release their diversity data to the public, and those who fail to comply with the new law may face a penalty as decided by the courts.
Asset managers tune out anti-ESG noise
Asset managers are tuning out political opposition to ESG when it comes to selecting investments but are being more careful in how they talk about ESG, according to a report from Cerulli Associates. Even though political controversy is swirling, asset managers are maintaining a commitment to ESG, according to the new Cerulli report. No participants surveyed plan to stop incorporating ESG considerations into investment decisions or expect to stop offering ESG/sustainable investment products, per Cerulli, yet, nearly one-third (30%) of asset managers will be more cautious about messaging around ESG-related activities through websites, marketing materials, prospectuses and other formal investment documents.
Research & Reports
Morningstar’s second annual Voice of the Asset Owner global survey, which surveyed 500 global asset owners, revealed several key findings: 1) The majority of asset owners believe that ESG is material to the investment process, and 67% believe ESG has become more material over the past five years. 2) Climate is the highest priority among asset owners, with many committed to net zero by 2050 initiatives, and they are interested in climate transition strategies that reduce real-world emissions, not simply reducing their own exposure to carbon-intensive companies within their portfolios. 3) Asset owners are looking for greater accuracy, quality and relevance when it comes to ESG data, ratings and indexes. And they’re looking to international standards, rating agencies and government regulators to help.