Top 3 ESG investing trends emerging from the COVID-19 pandemic

The global pandemic wreaked havoc on practically every aspect of our lives, exposing numerous flaws in our economic and social systems. Pollution, biodiversity loss, deforestation, social inequality, labor rights, and water shortages all pose real threats to economies, people, and the environment, affecting businesses, funds, investors, and consumers alike.

As the world emerges from this historic crisis and begins to rebuild economies and communities on more solid foundations, there is an increasing demand for solutions that have the potential to lead to significant change. In turn, ESG (Environmental, Social, Governance) investors are driving a demand for companies to implement resilient and renewable energy sources, workforce diversity, equitable compensation, and trustworthy, transparent data.

Sustainable investments received a $120 billion inflow in 2021, more than doubling the $51.1 billion received by ESG funds in 2020 and setting another new annual record. And it appears the upward trend will continue. Global ESG assets are expected to hit $53 trillion by 2025, according to Bloomberg, accounting for more than a third of the $140.5 trillion in total assets under management.

As ESG investing becomes more deeply integrated into the investment world, several clear themes are emerging.

Trend 1: Climate change

According to the World Economic Forum's Global Risks Report, climate action failure and extreme weather have dominated global risk concerns over the past 10 years. Natural resource depletion, biodiversity loss, forced migration, and livelihood crises are all potential dangers of these two threats.

S&P Global’s Trucost released research detailing how unchecked global warming will affect properties and assets owned by the world's largest corporations, such as mining, utilities, and processing plants. 60% of companies in the benchmark S&P Index own physical assets across 68 countries (with a market valuation of $18 trillion) that are susceptible to at least one type of climate change physical risk, according to the report.

As a result, climate change has become our world's most pressing systemic concern, one that has been driving ESG trends for more than a decade. That trend is expected to continue as we search for new and innovative tools to help us develop climate risk-aware investment strategies. While there are many complex facets of climate change, the current environmental conversation is revolving around two critical areas: greenhouse gas (GHG) emissions and biodiversity.

Carbon offsetting will become the norm
According to a recent study, climate change is currently responsible for five million deaths per year, and the World Bank estimates that over the next 30 years, climate change could impact 143 million climate migrants. Climate change is expected to have a profound impact on economic output as well. The Swiss Re Institute estimates climate change may wipe out up to 18% of global GDP by 2050 if global temperatures rise by 3.2°C.

So, what’s driving global temperatures to increase? The Intergovernmental Panel on Climate Change has reached a unanimous conclusion that human activities, such as burning fossil fuels and deforestation, are causing the Earth's temperature to rise, consequently warming the globe. GHG emissions have increased by more than 30% since the industrial revolution and the planet’s surface temperatures are approximately 1.0°C warmer than the pre-industrial period.

These facts have made carbon offsetting, compensating for CO₂ or other GHG emissions, a critical area of focus for governments, regulators, and investors. Companies, in particular, are heavily focused on reducing their overall GHG emissions as well as looking into various carbon offsetting options like planting trees, recovering damaged land, and using carbon capture and storage technology to remove CO₂ from the atmosphere.

Biodiversity loss
Biodiversity loss has negative consequences for livelihood and economies that are just as devastating as climate change. And biodiversity loss, the loss of diversity of living organisms on the globe, has dramatically increased around the world. With over half of global GDP moderately or severely reliant on nature, according to the World Economic Forum, the mass extinction of species has become an increasingly serious concern for businesses and investors.

While voluntary disclosure of biodiversity impacts is currently uncommon, some countries are now requiring investment corporations to declare their environmental footprints. On January 1, 2022, the European Union Sustainable Finance Disclosure Regulation (SFDR) went into effect, requiring investment firms to declare activities that have a negative impact on biodiversity-sensitive areas.

Trend 2: Social inequalities

Social factors have gained the spotlight as the COVID-19 crisis created significant challenges that heightened social gender and pay inequalities. Millions of women left the job market to care for their children during the pandemic as schools and day cares closed to prevent the spread of disease. The pandemic also greatly affected industries dominated by women of color, including food service, leisure, hospitality and retail. Consequently, awareness of and action around diversity and inclusion has never been more important, especially as economic recovery allows for the inclusion of displaced groups.

When it comes to building financial resilience, taking social hazards into account can make a profound impact. Health and safety regulations, for example, are an upfront cost for businesses, but they lower the chance of costly lawsuits. Diversity and inclusion are becoming increasingly important for ESG investors, particularly in two significant areas: equal gender pay and CEO remuneration.

Equal gender pay
A gender pay gap is a measure of the difference in average compensation between men and women throughout an entire organization, business sector, industry, or the economy as a whole, regardless of the nature of their work. According to an analysis of full- and part-time workers' median hourly wages in 2020, women earned 84% of what men earned. This means it would take an extra 42 days of work for women to earn what men did in a year.

This wage disparity between men and women is a contentious issue that’s gaining traction. Those who believe the gender wage gap is a pressing problem have growing opportunities to invest in companies that prioritize being on the forefront of this issue, and companies that actively improve gender equality represent a buying opportunity for ESG investors.

Companies risk losing the very leaders they need right now if these issues aren't addressed quickly. Teaching company leaders to close gender pay gaps, recognize the individual talents of their team members, create a diverse workplace, and reward employees for good work can help build trust and a more inclusive, happy, and productive work environment.

Executive compensation
The polarization of race and gender isn't the only source of inequality in today's society. The epidemic worsened economic wealth gaps, resulting in substantial pay discrepancies between workers and executives, for which companies have been increasingly criticized.

The Economic Policy Institute found that CEO pay has skyrocketed 1,322% since 1978. In 2020, a year when 114 million jobs were lost due to the COVID-19 pandemic, CEOs were paid 351 times as much as a typical worker. This surge in CEO pay has aided the expansion of the incomes of the top 1%, leaving fewer economic growth opportunities for ordinary workers and widening the income gap between the top 1% and the bottom 90%.

As a result, many are advocating for policy changes that would both reduce incentives for CEOs to extract economic concessions and limit their ability to do so, for example, reinstating higher marginal income tax rates. Linking CEO pay to ESG targets is another strategy that has gained traction in recent years.

Trend 3: Better ESG data

The number of companies reporting on sustainability efforts has increased as more investors demand detailed ESG reports. According to the Governance & Accountability Institute, 92% of companies in the S&P 500 Index issued sustainability reports in 2020.

However, ESG data can be inconsistent, composed of a patchwork of reporting frameworks that make it difficult to collect and compare. While many companies are likely to boast about the ESG goals they are achieving, clear and uniform reporting standards are still in their infancy stage as regulations and investor preferences evolve.

Better data is the key to improved transparency and stronger ESG integration. The good news is the quality and quantity of ESG data are improving as reporting standards are transitioning from voluntary to mandatory and companies begin to compete for sustainability-focused investment capital.

As the need for data requirements grow, certain reporting frameworks, such as the Value Reporting Foundation’s SASB Standards, the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD) are emerging as leaders.

Uniform data requirements will make it easier for companies to report on progress toward their ESG commitments and goals, and for market participants to identify, compare, and act on ESG risks and opportunities.

ESG materiality assessments

With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.

An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.

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Ryan Nelson

Ryan Nelson is Conservice's SVP & General Manager, ESG. He has over 20 years in enterprise software and management consulting experience, including supply chain software implementation and process optimization for fortune 50 companies. Since 2009, Ryan has been focused on helping companies amplify their ESG impact with technology.

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