ESG and SRI are acronyms we see more and more without always understanding what they mean and what they encompass.
ESG is Environmental, Social and Governance research. And SRI is Socially Responsible Investment.
Extra-financial data are analysed and then incorporated into investment management. But what value do these extra-financial data provide for the management of savings?
Extra-financial data highlight the level of companies’ involvement in sustainable development issues and how relevant such initiatives are.
A large company, such as Renault or Danone, can supply 1000 to 1200 extra-financial datapoints falling into the three pillars of extra-financial research:
A company that fails to comply, or sufficiently comply, with good extra-financial practices risks controversy or scandal.
Boeing learned this the hard way. The uncovering of safety flaws in its aircraft also masked issues in its corporate culture. This had an enormous impact on its share price, which fell from more than 400 dollars to 100 dollars in a few months, with a loss of market capitalisation of more than 200 billion dollars. Boeing was punished hard by extra-financial analysts and managers.
In Germany, the Wirecard scandal sent the payments platform and financial services firm into bankruptcy for massive accounting fraud. And yet, warning signs had been visible 18 months previously, but Wirecard took no concrete action. Its response failed to satisfy extra-financial analysts and steered them towards potential governance issues and hence, downgrades in the company’s extra-financial rating. This ultimately shed light on mismanagement at Wirecard and sent it into bankruptcy.
In this type of crisis situation, the SRI manager can sell off a stock or reduce his exposure at an early stage when ESG criteria are not met sufficiently or not at all.
Socially Responsible Investment (SRI) is a filter that is part of the investment management “dashboard”, just like financial items. But unlike financial items, which are standardised, extra-financial research is still subject to some interpretation and the freedom of focusing on one or more thematics chosen. At OFI Asset Management, some funds, for example, focus on social aspects, others on the energy transition.
Extra-financial research classifies companies within sectors and ranks them in order to guide fund managers’ choices on extra-financial aspects of companies and particularly risk levels and strategy. In our view, a company that incorporates ESG criteria into its long-term strategy is more resilient to an extremely complex economic environment and achieves better equity market performances, all the while being less risky.
This is a combination of risk analysis and detection of future opportunities.
What does an SRI manager do with a stock that fails to comply with ESG criteria? Delete it from his selection grid or try to influence the company’s strategy at shareholder meetings to make it more virtuous?
One focus of extra-financial management is in analysing best practices. This assists companies in identifying avenues for improving their ESG performance.
Exercising voting rights at shareholder meetings is also an important component of extra-financial management, as it is meant to encourage companies to adopt better practices. A few years ago, resolutions and votes from minority shareholders were held in little regard. Things are much different now, thanks to regulations that have pushed companies to may more attention to these aspects and to publicise them more.
There have also been changes in the energy transition. Companies are making a greater effort to save energy and are to produce “green” products with an eye to the future.
Investors seeking sustainable finance
The pandemic-stricken 2020 was an unusual year to say the least. And yet, extra-financial flows were four times heavier than in 2019, an already exceptional year. Companies are indeed becoming aware that good practices drive out bad and generate inflows into virtuous investments, and vice versa.
SRI aims to manage risk (by detecting risks within companies) and to identify medium- and long-term opportunities arising from the steady improvement in companies’ behaviour and in their sustainable management practices.
This content was originally published in French on the Boursorama website as part of the program "Ça vaut le coup !"