Rising inflation and the risk of a global recession can have a polarizing impact on investors. Some may panic and look for short-term returns, while others will prioritize long-term value. According to Justine Vroman of Aviva Investors, buy-and-maintain investment strategies depend on understanding long-term ESG risks.
Yet, the longer an investor’s time horizon, “the less you can rely on quantitative models of a company’s balance sheet and the more weight you have to give to qualitative assessments of how the business will react in the face of long-term trends,” says Vroman.
Long-term value at risk
Barack Obama warned that social media platforms "have to have a conversation about their business model that recognizes they are a public good as well as a commercial enterprise." But quantifying the value of a “public good” is a challenge.
Prioritizing shareholder value, Elon Musk fired half of the 7,500 full-time Twitter employees on November 4. These included content curators, software engineers, and other workers with insights into the inner workings of the platform. ESG risks are materializing as a result.
Immediate breaches in data security may prompt enforcement of a settlement reached with the FTC, but it is impossible to predict how consumers will respond, if they feel the “public good” Twitter once offered is lost.
Similarly, research suggests climate change could cost the US economy $2 trillion by 2100, yet no one can predict exactly when these losses will materialize. Former governor of the Bank of England Mark Carney addresses the challenge in his famous “Tragedy of the Horizon” speech. “Once climate change becomes a defining issue for financial stability, it may already be too late.”
Companies without a transition strategy could face increasing risks linked to consumer behavior changes, litigation, technology changes, and regulations.
It’s natural for investors to try to gain more insights on how ESG issues impact long-term value. Researchers have turned to credit default swap (CDS) spreads as one metric for quantifying ESG risk across different time periods.
- One study finds that high ESG ratings correlate with a slight decline in credit CDS spreads in the long-term more so than in the short-term, but the results differ based on the specific ESG issue being analyzed.
- Another study finds a stronger CDS spread decline for US- and Europe-based companies from 2007-2019 with medium- as opposed to low- or high-ESG ratings.
However, ESG insights are generally hard to quantify due to the rat’s nest of data available. According to the OECD, data challenges of “transparency, metric consistency, ratings methodology comparability, and alignment with financial materiality” are key challenges to ESG investing.
Starting with high quality data is critical to ESG risk assessments. YourStake gives ESG Fund Managers advanced data transparency with its signature NoScore approach.
We address the problem of insufficient and inconsistent data by using third-party sources, hosted by government agencies, academic institutions, or trusted NGO sources. Test out the platform for free to explore our data.
That escalated quickly
ESG risks can quickly materialize, and when they do, investors prioritizing long-term value tend to be the least affected.
A global pandemic had been predicted for years before the onset of COVID-19, yet many firms remained unprepared to adapt to the “new normal” of lockdowns and contagion. ESG risks such as occupational health and safety, gender inequity, supply chain disruption, and price volatility became acutely material for many firms almost overnight.
Deliveroo’s London Stock Exchange IPO is another case in point. While at first, it seemed this company would have the highest IPO since Glencore in 2011, those estimates quickly faded. A series of ESG risks among other issues linked to the company’s overvaluation turned the bright star into LSE’s biggest IPO loser.
For one, the company’s valuation was dependent on a gig economy workforce, but litigation requiring worker employment started to impact the company’s profitability. ESG risks linked to litigation, worker pay, health and safety, and executive compensation were some of the reasons UK’s largest fund managers chose not to invest in Deliveroo.
Embedding ESG values
Developing an investment strategy that encompasses long-term ESG issues requires more than quantifiable data. Values can fill the gaps for identifying long term value where quantifiable data is not available.
Our Yourstake platform is designed for advisors who aim to help align client values with their portfolios Our behavioral values questionnaire helps advisors understand how clients approach topics across ESG issues as they view them.