“Sustainability”, in the broadest sense of the term, has long ceased to be a new concept for investors. It encompasses, among other things, “corporate social responsibility” (CSR) and “environmental, social and governance” (ESG) criteria. But what does all this mean for investing? This study explains the concepts and examines how ESG has become increasingly important in the investment world. 

Sustainable investment has gained significant momentum in recent years. While it remains the playing field of institutional investors, the share of retail investors is increasing, and is likely to increase even more rapidly in the future. Not least because the index supplier MSCI and the fund rating agency Morningstar are providing benchmarks and funds with ESG ratings.

The acronym ESG (Environmental, Social, Governance) can be understood as connecting corporate sustainability criteria with investment decisions. Through ESG, sustainability also pervades individual investment styles. Recent developments show that sustainability is increasingly regarded as an assessment criterion for minimising investment risks and enhancing overall returns and no longer as an anti-performance investment approach.

One thing is for sure: the fact that rating agency Morningstar and benchmark provider MSCI started using ESG criteria in early 2016 as a basis for assessing all funds and benchmarks, regardless of whether they are managed on a defined ESG basis, is a big step in the direction of a general acceptance of these investment criteria. “ESG goes mainstream” is the buzzword, as the higher the transparency, the higher the demand is likely to be for using sustainability criteria.

„E – S – G“ 

„E – S – G“Corporate social responsibility is to companies what ESG related criteria is to analysts and investors. ESG criteria can be seen as the common denominator for companies on the one hand and analysts / investors on the other.

The acronym “ESG” stands for Environmental, Social and Governance (the latter meaning corporate governance). The term and concepts for ESG criteria were first introduced in 2004 by the United Nations’ Global Compact initiative, in order to provide analysts and investors a set of standards based on the United Nations’ “Six Principles for Responsible Investment”.¹

There is no all-encompassing and definitive understanding or definition of ESG criteria. The Sustainability Accounting Standards Board (SASB)², an independent non-profit organisation, has committed itself to defining accounting standards for unified ESG-based valuations. The following overview of ESG criteria was derived from these standards, based on three main “E, S and G” criteria and expanded with a few points from the “Principles of Responsible Investment”^{3; 4:}

ESG criteria can be further developed on this basis, for example by making them measurable and applicable in the form of key performance indicators, but without establishing a fixed set of criteria that, in the United Nations’ view, cannot be definitive as it would quickly become outdated ⁵. The strength of KPIs can be seen in the fact that they can be tailored to each sector and then integrated into company research.⁶

Strong increase in importance in recent years

CSR / ESG investments have long outgrown their status as a mere investment niche. This is reflected not just in their growing volumes – i. e., the money that is managed in accordance with CSR / ESG principles – but also in the growing body of research into this form of investment. Friede et al. estimate that the cumulative number of academic studies, which compare companies’ ESG and financial performances, reached a record high of 2,000 studies in autumn 2015.⁷

Assets managed according to ESG criteria have expanded just as dynamically. Money managed on the basis of the United Nations’ principles of Responsible Investment (PRI) now amounts to about USD 68 trillion – half of globally managed institutional assets.⁸

Institutional investors still dominate the market, but retail investors’ interest in sustainable investment is rising. While institutional investors accounted for 90 % of sustainable investments in 2012, the figure had fallen to 74 % by 2016.

Broken down by asset class, the lion’s share goes to equities (50 %) and bonds (40 %). Real estate, private equity and other forms of investment are much less represented, due no doubt to their lower overall market capitalisation in comparison with the two aforementioned asset classes.⁹

A shift in analyst views

Another interesting fact: analysts also appear to have changed their views on CSR. Ioannou and Serafeim found that analyst recommendations in the early 1990s were rather negative on companies with high CSR ratings, but the situation has radically changed. Nowadays, a positive CSR rating increasingly has a positive impact on the overall valuation.10 The perspective has evolved: CSR – and, accordingly, the observance of ESG criteria – used to be regarded as additional cost but is now seen as a way to enhance company management and investment returns. This raises the question whether, ultimately, it pays off to invest sustainably. Ideally, a sustainable investment approach should not be a drawback for an investment’s risk-return profile.

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^{1 Cf. ”PRI Reporting Framework 2016 Main definitions”, UNEP Finance Initiative, November 2015
2 www.sasb.org
3 http://materiality. sasb.org/
4 PRI Reporting Framework, Main Definitions, 2013ile.
5 Cf. UNEP Finance Initiative & World Business Council for Sustainable Development, “Translating ESG into sustainable business value”, March 2010
6 Cf. also EFFAS & DVFA, “KPIs for ESG“ Version 3.0, 2010
7 Cf. G. Friede, T. Busch, A. Bassen: ESG and financial performance. Aggregated evidence from more than 2,000 empirical studies, in: Journal of Sustainable Finance & Investment, 5. Jg. (2015), H. 4, p. 210–233
8 unpri.org. Data as of 23 May 2018
9 Global Sustainable Investment Alliance (GSIA):
10 Cf. I. Ioannou, G. Serafeim: The impact of corporate social responsibility on investment recommendations. Analysts‘ perceptions and shifting institutional logics, in: Strategic Management Journal, 36. Jg. (2015), H. 7, p. 1053–1081}