An Alternative to ESG Factors
An increasing number of investors have become aware of the need for sustainability in their investments and have resorted to using environmental, social and governance (ESG) factors when identifying projects and investments.
Environmental factors consider an investment’s role in protecting or sustaining the environment. Social factors examine how it cultivates and maintains relationships with key stakeholders such as customers, suppliers, communities and employees. Governance considers how it approaches issues such as executive pay, leadership structure and internal controls, among others.
Younger investors, in particular, have shown a keen interest in integrating ESG factors in their investment decisions. Likewise, mutual fund companies and brokerage firms have begun to offer products that adhere to these principles, leading to substantial growth in assets held by investors that are selected using ESG criteria.
While ESG factors have made sustainable investing mainstream, some believe there is room for alternative factors. Jon Bennion-Pedley, the Chief Executive Officer at Investment Owl, is among those who feel alternative factors can help investors consider more than sustainability. These include:
· Exit: With the exception of philanthropists, investors put their financial resources into companies or projects intending to get their money back. According to Jonathan Bennion-Pedley, investors shouldn’t consider a deal if the exit terms are unclear. Similarly, investors should stay away from investments with ill-defined exit terms, which might commonly be packed into a single, vague statement.
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This information is according to a 2019 KPMG report on the global trends towards responsible investing.
· Simplicity: Mr Bennion-Pedley believes that investors should stay away from investments that are hard to understand. Individuals who lose money on deals typically didn’t understand critical elements of the investment, the inherent risks and the reward prospects. According to him, many of these hard-to-understand investments are often those that are enticingly packaged.
· Groups: Various groups of people are responsible for the success of an investment, including the people running the investment (the management team), the base of existing investors, and those promoting it. Having the wrong group of people behind an investment will lead to its failure. As such, investors are encouraged to meet the team, if only to get a sense of who they are, what the average investor has put in, and how the business is operated.
A savvy investor can use both the conventional and alternative ESG criteria when assessing their options. The former criteria help identify sustainable investment opportunities. The latter assures an investor that a potential deal is easy to understand, has a clear exit plan, and is managed by a credible (and capable) group of people who value their reputation.