Sophisticated investors and fund managers are now more aware on environmental, social and governance (ESG) issues and the potential of this investor sector. For many asset owners and asset managers, integrating so-called ESG into their investment processes is no longer an optional extra but a necessity.
They feel that ESG investing, in theory, is a potential win-win strategy for all, providing improved sustainable long-term returns to investors and serving the wider public interest. Is this optimism justified?
There is some suspicion that some in the fund management industry might be using ESG investment less as a genuine felt force for good, then a high-profile marketing gimmick to help generate funds flow, especially from investors who saw the excesses of the investment industry following the global financial crisis of 2008.
A key question is whether investors in general really know what they are getting into the ESG investments and socially responsible investments in general?
There could be lingering doubts on how fund managers, who were involved in the earlier excesses of the financial crisis such as leveraged derivative instruments, could suddenly be converted overnight?
Are regulators looking closely at this new sector to ensure that it really delivers on its ESG promises, especially the fund manager’s ESG engagement strategy and how such investment factors are embedded in their remuneration policies?
Investment decisions are based on obtaining credible information and data and must often fund managers rely on third-party information providers, as it is less onerous and costly.
Investment decisions are based on obtaining credible information and data and must often fund managers rely on third-party information providers, as it is less onerous and costlyDr. Mohamed Ramady
Sometimes the introduction of sophisticated ESG indices, specifically tailored to the demands of the ESG investment community, as by acquiring insight and membership of ESG indices, fund managers can access the increasingly deep pools of ESG capital and lower their own cost of capital.
However, to fully deliver on the promises of transparent and true ethical investment, fund managers must develop and implement strategies that will stand up to scrutiny not only by regulators but by sophisticated investors and the general public.
Lines must not be blurred, and if they do, this will tarnish the reputation of the ESG niche market.
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Investment strategies should be disclosed in more detail to enable current and prospective investors and other stakeholders to hold these ESG managers to account. Just advertising that they are ethical investors and leave it at that will no longer be acceptable.
There are those that will point out that ethical and socially responsible investment is not new and that Islamic financial institutions have been doing this long before it became fashionable or acceptable in conventional banking circles.
The Islamic finance sector has grown exponentially over the past two decades and offers a wide variety of Shariah compliant investments, with regional banks taking the lead from foreign banks operating specialized Islamic units or earlier pioneering Malaysia based institutions.
However, even in this sector it has not been easy with criticism of unqualified oversight Sharia supervisory committee members, leading to accusations of Fatwa or Shariah approval edicts being compromised, leading to so – called Fatwa shopping and different Shariah committees approving or disapproving of the same products, and with few external professionally qualified audit oversight.
One of the more contentious issues was on investing in Sharia compliant companies with debt or leverage on their balance sheet , leading to different opinions on the level of acceptable company debt , whether this is less than 5 percent or can reach levels up to 30 percent.
The matter has significant investment consequences, as the lower the debt ratio the fewer are the number of companies that the Shariah committee can recommend to invest in.
This seems to have changed and Shariah committee members are now more knowledgeable of different Islamic financial products and their derivatives and have made an effort at arriving at common acceptable fatwas on certain product offerings, and several countries have established Islamic Regulatory authorities given the potential reputation risk for such financial centers in audit and compliance irregularities.
The onus of oversight and compliance to verify what is being offered as being truly Shariah compliant and ethical has shifted to the regulators instead of being shouldered by pious Muslims who invest on the belief that they are doing the right thing ,and if there are any irregularities then those that are responsible will be punished by the Almighty.
The ESG investment world has now come of age and is here to stay as a serious investment alternative. Ensuring to strict compliance on stated investment objectives will ensure that ESG is not a mere fig-leaf for fund manages but will deliver the full potential of this worthy sector.
Investors expect no less for having faith in social responsible investments to avoid the excesses of investment banking greed.
Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co-author of ‘OPEC in a Post Shale world – where to next ?’. His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.