3 key challenges in ESG investing - WealthTech After Hours
Impact investing is becoming more accessible to UK’s private investors, and many are jumping on board the ‘doing well by doing good’ wagon by trying to balance their portfolios with positive impact and positive returns.
The ESG investing market recorded £2 billion of investment last year - a 127% increase since 2018, but investors need to look beyond the ESG label.
To discuss the realities and challenges in ESG, WealthKernel hosted a panel focusing on the impact of climate change on investing and the rise of ESG-related products in fintech.
Summarising the great discussion with our panelists and audience - there are problems with 'ESG' as a label, but the industry is making good progress in fixing them.
Here are a few takeaways from our ESG investing panel -
ESG is a problem with many layers, especially the lack of data availability and transparency
A poll by Capital.com showed that most Do-It-Yourself (DIY) traders and investors do not prioritise ESG factors when making trading and investing decisions because of a lack of knowledge and high fees.
Credible data standards are needed for proper investment analysis, the lack of which is complicating ESG investing practices. Some of the suggested areas of improvement are:
- Data Availability - Despite the popularity of ESG, investors struggle to conduct proper due diligence, manage risks, measure outcomes and align investments with sustainable and long-term value.
- Data Variance - Investors face difficulties assessing an ESG stock or company, as ESG ratings vary significantly from provider to provider. The differences in ratings typically occur due to changes in frameworks, measures, key indicators and metrics, data use, and qualitative judgement.
- Fragmented Data - Tracking ESG data for proper analysis is a challenge as the data is usually stored across multiple sources such as CSR reports, the company’s website, regulatory filings and the company’s annual report.
At a time when ESG stocks are hot and sustainability is a rising priority in a world facing a climate crisis, tackling the data hurdles in the industry has never been more important.
ESG Investing can increase asset concentration risk
There is a rise in asset concentration due to increased inflows into popular, high-scoring ESG funds. Asset concentration in a single industry can increase volatility and expose the funds to losses if the selected industry underperforms; and can lead to inflated stock prices of select names, putting them out of reach for retail investors.
A study by Schroders says that excluding non-sustainable assets from the portfolio can increase the concentration risk. It also found that investors operating an “integrated” sustainability approach also increased risk levels, compared to portfolios which did not follow a sustainable strategy.
Experts say that while investors are comfortable with risk budgeting, sustainable budgeting should also be on our radar. In other words, the additional risk investors can tolerate to accommodate their sustainability values.
Carbon credits are mispriced and allow companies to get away with paying lip service
The carbon market (or the cap and trade regime) sets a limit for companies on the amount of greenhouse gas emissions they can emit. The companies that exceed the limit must make up the difference by buying carbon credits from an ‘under-emitter’, and the ones that stay within their limit (the under-emitters) have a carbon surplus and can sell it to companies such as above.
Carbon credits, currently, are priced unsustainably low due to a credit surplus in the market. With prices as low as $3-5 per metric ton of CO2, companies can risk facing claims of greenwashing or get away with it by buying more credits.
Using unregulated and cheap carbon credits can mask the insufficient efforts by companies to curb emissions and slow down the delivery of climate change targets.
As a result, there is a growing concern over the integrity of the carbon credits trade due to poor transparency and regulation. Experts fear that prices of carbon credits are far below the level needed for climate change efforts.
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