The dynamics of economics, investment, and ESG
At its core, the field of economics is about the dynamic process of allocating scarce resources to supply the goods and services that meet the demands of a society. Investing, at its core, is about committing capital to those businesses or assets that demonstrate the ability to produce goods and services in the most efficient manner, such that an adequate financial return is earned for assuming the risk of capital loss. These businesses, and the returns they generate, also must prove to be sustainable over time such that maximum value can be derived over the long term from the investment.
ESG factors relate to all of the key dimensions highlighted above when weighing investment decisions. Also, the relationship between ESG and companies is a two-way street: companies’ financials may be impacted by ESG factors and, likewise, companies’ operations may impact ESG issues, as well.
Scarce resources
The war in Ukraine has illustrated the harsh reality of scarce natural resources in modern economies. Surging commodity prices, especially in the energy sector, are the most prominent example.
Critics have charged that ESG mandates are contributing to the near-term energy supply issues due to the reduced amount of capital directed toward energy production. But ESG investments have been helpful in directing capital to transition energy supplies from unreliable and sometimes autocratic foreign governments to more reliable and sustainable sources, including both fossil fuel and renewables.
Companies that aggressively look to manage costs related to commodity prices through reduced usage, or to find cheaper sustainable alternatives, will not only contribute to an important ESG metric – carbon footprint – but also may enhance corporate profitability and financial resiliency.
The Covid-19 pandemic has been a catalyst in demonstrating a new reality of increasingly scarce human resources in modern economies. Globally, corporations are dealing with labor shortages and aging populations by not only increasing wages, but also by pursuing other strategies that could be considered socially favorable, such as flexible work scheduling, training, profit sharing, and actively recruiting staff from what may be considered diverse segments of the population.
Again, these initiatives are being pursued not just because they benefit social ESG metrics, but because they are helpful in reducing turnover, improving efficiency, obtaining a broader perspective, and sustaining the organization for the long term.
Demands of society
Companies are responding to persistent consumer demand for responsible products. A vast number of consumer-oriented products now are labeled “renewable,” “responsible,” “sustainable” or some other term suggesting that the company that produces it is being thoughtful about the resources it uses in the production process. Although there are certainly instances where the ESG label may just be greenwashing – the act of disseminating disinformation by a company to present an environmentally responsible public image – the point is that consumers are increasingly demanding products that minimize the impact on the environment and the well-being of communities.
Companies know that their customers, employees, and other stakeholders care about the way they conduct their business and the impact they have on the world. The number of companies issuing corporate social responsibility (CSR) reports has gone up, and even small companies are increasingly measuring and reporting sustainability data.