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Sustainable Investment and ESG Performance

Ahmed Abdelsalam
Abu Dhabi University, Email: 1056272@students.adu.ac.ae

Saree Barake
Abu Dhabi University, Email: 1063765@students.adu.ac.ae

Ali Elcheikh
Abu Dhabi University, Email: 1065137@students.adu.ac.ae

Supervised by:

Professor Haitham Nobanee

Abstract

Earlier literature seems to lack more insights on sustainable investment drivers. For this

reason, this paper evaluates the relationship between environmental and social aspects,

market conditions, and issues on corporate governance about sustainable investment. Despite

the growing popularity of sustainable investment over the last 20 years, sustainable

investment is preceded by socially responsible investment, green and ethical investment. For

purposes of understanding sustainable investment before decision making, the paper proposes

a certain set of attributes to evaluate sustainability by employing the linguistic preferences of

an investor. The proposed attribute measures are tailored to an investor’s preference. Besides

providing literature on ESG and market risks connection to sustainable investment, the study

discusses certain aspect criteria that are pivotal in corporate governance.

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Introduction

Globally, sustainable investment has proven to be an ideal practice with many companies

looking to see if they could understand its components and adjust accordingly Hawn et al.,

2018). As an investment procedure, sustainable investment potentially impacts sustainable

development by the coordination of long haul social, environmental, governance criteria and

monetary concerns during investment decisions. Therefore, sustainable investment is a green

and ethical investment that employs both socially responsible investment (SRI) and ESG

investment procedures (Tseng et al., 2019). No wonder the current rise in sustainable

investment research has prompted both scholars and policymakers to assess the existing

interrelationships in the aforementioned factors concerning sustainable investment.

This research paper aims at building on already conducted research by Ferreira through

carrying out a systematic research review on a sustainable investment field (Talan & Sharma,

2019). For the past few decades traditional companies aspiring to make profits have had an

increased interest in understanding and taking care of wider impacts of their businesses.

Nevertheless, Non-Governmental (NGOs) governments and corporations have all fell short in

their endeavours to solve certain global issues like climate change, inequality, and poverty.

Thus, sustainable investment has proven to be a key solution to the environmental and social

challenges by making the financial markets increasingly responsible for the ESG effects

(Talan & Sharma, 2019).

Consequently, every investor now longs for investment ventures that reflect on various

issues including environmental, social, ethical and even more complex issues. This is in

addition to paving way for sustainable and value-based investment. Sustainable investment is

thus defined as the integration of environmental, social and governance (ESG) aspects in

making investment decisions (Cubas‐Díaz & Martinez, 2018). As much as there is evidence

of the existence of sustainable investment in the 18th century, it has become popular in the last
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20 years. That being the case, most researchers dealing with sustainable investment in the

year 2000 and beyond have thus shifted their focus on empirically-based articles on

performance, activism and sustainability that touches on extra financial gains as opposed to

the theoretical articles in 1980 and '90s cantered on personal values such as morality,

sacrifice, and religion (Hale, 2016). By definition, extra financial returns refer to the value

that investors sort for besides financial returns in which ESG is the answer (Almansoori &

Nobanee, 2019).

Lately, the rise of sustainable investment as an academic field has been put to light

through the occurrence of issues, journals and academic conferences cantered on sustainable

development. As a matter of practice, indices and money focusing on sustainable investment

have increased in the last few years. Some of the indices established over the last two

decades include the FTSE4Good Index BY the Financial Times Stock Exchange inaugurated

in 2001, and the Johannesburg Stock Exchange (JSE) Socially Responsible Investment (SRI)

index inaugurated in 2004 just to mention but a few. On the other hand, there are also social

investment funds like the Vanguard FTSE Social Index, Social Choice Bond Fund, ad

Parnassus Core Equity Fund among others (Talan & Sharma, 2019).

In matters of sustainable investment, the incorporation of ESG factors remains the fastest

growing and the most ideal approach. Nevertheless, in spite of the global recognition of

sustainable investment and its ESG related components, there is still a lack of steadniness

across various areas both in principle and practice (Al Hammadi & Nobanee, 2019). As is the

case, it seems like it is majorly practiced In America, Australia, and Europe as opposed to

developing nations. Similarly, strategies on ESG have equally resulted in inconsistency in

decisions on sustainable investments because of certain reasons. Besides asset managers and

investors usually issuing varying emphasis on every ESG criterion as they establish

portfolios, governance fails to be recognized as the primary ESG strategy integrating factor
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but just like a pillar such as environment and society (Escrig-Olmedo et al., 2017).

Moreover, Kempf & Osthoff established that mutual funds that are ESG driven not only

resulted in additional cost but also led to increased expenses ratios. As much as ESG is a

reflection of a promising sustainable investment framework the above-mentioned issues raise

concern over the approach's legitimacy (Escrig-Olmedo et al., 2017).

This paper aims to try and take account of the already undertaken research on sustainable

investment. That being the case, this research takes the form of an orderly review

methodology as advised by Davies, and reiterated by Tranfield Denyer & Smart. The paper

thus examines the field of sustainable investment and what is required to ensure it is fully

achieved. Factors to be considered include environment, social, and corporate governance.

Literature review

Sustainable investment and ESG

Sustainable investment remains an area of interest in the academic world as scholars

and practitioners seek to analyse investor preference on socially responsible investments with

value for ESG global market characterized by uncertainty and volatility (Almarar, &

Nobanee, 2019). According to Clark & Monk, (2017) investors usually depend on updated

information for making decisions on stock picking for long-term market trends forecasting.

The need for intrinsic information Is vital for both non-financial and financial data with

sustainable investment decisions stimulated supported by the scrutiny of a company's

financial and ESG data in the market or sector. Nevertheless, Hassan & Roychowdhury

(2019), notes that quite a huge chunk of literature highlights the absence of quality and

comparability with the disclosure of ESG. According to Knight and Dixon (2011), the above

argument is meant to limit ESG related information uptake and prevent the implementation of

practices on Sustainable investments.

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Over the years, different national and international bodies like the International

Integrated Reporting Committee (IIRC) and Global Reporting Initiative (GRI) which are the

task force on Sustainable Accounting Standards Board (SASB) and Climate-related Financial

Disclosure (TCFD) have worked to make disclosure practices and corporate measure more

effective (Dumay et al. 2017). Nevertheless, the set frameworks are still somewhat voluntary

and haven't achieved a universal adoption and consistent standard fete (Gill, 2011).

According to KPMG (2017) report whatever is in place is a fragmented, yet dynamic global

environmental regulation about ESG disclosure (Diouf & Boiral, 017). Thus, the quality of

the currently available information varies depending on investment markets and countries

together with individual sectors about ease of measuring and comparing ESG factors.

According to Curran & Moran (2007) investors are said to be left straggling to rely on

incomplete and heterogeneous ESG information due to habitual homogenous financial

information (Yilmaz et al., 2020). Similarly, investors are said to be confronted by high costs

on research in attempting to evaluate and locate ESG data (Yilmaz et al., 2020)

Generally, sustainable investment value affects the society, green environment and the

economic performance of a firm. This implies that investors ought to have screening methods

in the selection of an investment target under the lens of ESG performance of a firm. The

outcome is that in terms of risk-adjusted return's ethical pension plans that invest in

organizations with SRI receive equal financial gain with those of ancient pension plans. The

implications are that companies in stock markets focus on green investment that permits an

improvement in SRI that result in improved technical feasibility, cost-effectiveness,

production methods and performance level with equal financial gains.

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Social Impacts

Exploring initiatives with social impacts is a win-win situation and often appeals to

employees and consumers who are socially conscious (Diouf & Boiral, 2017). Through

criteria 1, social impact is depicted as the quality of employment and standards of living

through social changes set up with business practices, goals, and profits. That said, conscious

investors at times show their backs on their preferred ventures at the mere feeling that they

are not advocating for societal and environmental issues. As per the 3rd and 4th criterion

respectively, a firm's role is the stakeholder community while also availing products and

services that adhere to green SRI. Moreover, (C2) demonstrates that workers should be those

that are eligible for the existing laws and regulations and impact positively on the stakeholder

community. Thus, it's vital to have the backing of your stakeholders to witness at first- hand

what you do for your community. Some of the ways to practice social impacts include

donations to communities in both monetary and non-monetary terms towards social causes.

Besides, multinational firms have loads of resources at their disposal which they could

dedicate to charity. Nevertheless, (C5) stresses the fact that organizations still ought to

increase their philanthropic contributions.

Environmental Management

Environmental Management refers to an approach aiming towards exploring a pragmatic

strategy for the conservation of water, energy, and materials while minimizing the negative

impacts on the environment thus reducing any irreversible ecological damage characterized

by depletion of resources and carbon emission (Cubas‐Díaz & Martinez, 2018). As can be

seen in C6, resource minimization pinpoints the attributes that result from a rise in needs

satisfaction and protection of resources. As in C8 production is applied to the innovation of

products and services. For example, a firm ought to pay attention to the efficiency of its

energy consumption (C9). Therefore, a proactive management of the environment is a win-

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win proposition since, its aids in minimizing property cost, protect unique destinations, and

also make a firm achieve recognition for environmental leadership.

Economic performance and Market risks

Market risks are characterized by the likelihood of a financier undergoing loses resulting

from risks that impact the financial performance of a market as a whole (Tseng et al., 2019).

Consequently, market and specific risks are identified in C14,15,16, and 17 as oil prices,

exchange rate, US interest rates, and inflation respectively and are considered risk spill overs

receivers. Nevertheless, the aforementioned market risks depend on the performance of

corporate governance. On the other hand, the United States interest rates take care of the

inflation volatility that may go hand in hand with fluctuation in interest rates as a result of

fundamental attributes like announcements from the central bank regarding changes on US

interest rates.

Corporate governance

Corporate governance pinpoints the distribution of rights and responsibilities amongst the

stakeholders like managers, auditors, regulators, board of directors and the rest of

stakeholders (Al Hammadi & Nobanee, 2019). Similarly, it also encompasses the rules and

procedures regarding decision making in the affairs of the firm. As illustrated in C18, 19, 20,

and 21 all the mentioned stakeholders are subjects of all the stated processes through

transparency and corruption, compensation policy/executive pay, diversity of the board

members, and reporting's on sustainability respectively. These objectives are put in place and

pursued under the lens of regulatory, social and the market environment.

Discussion and conclusion

From the above-proposed measures on aspects and criteria on ESG factors, there is hope

for achieving sustainable investment. As opposed to the traditional valuation of companies

that focused on the deployment of financial capital on generating returns, the current
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framework proposed by Morgan Stanley also stresses the deployment of social, human,

natural capital as well as transparency on corporate governance as a way of achieving

sustainable investment. Stanley's approach to company valuations is a reflection of what

future successful companies will be which is, deployment of the above types of capital

responsibly.

Material ESG factors have the potential of impacting the financial performance of a

company and stakeholders returns through numerous channels. For instance, improved

energy efficiency and resources have a ripple effect of trickling down to reduced costs, while

improved management of human talent can increase output. Moreover, improved health,

tough environmental rules and regulations can minimize risks associated with serious

accidents; similarly, new trade fairs on green products that appeal to consumers can boost

revenues.

Take for instance an investment that increases the efficiency of data centres using 10-

20 times additional energy in comparison to average commercial structures which are

considered accountable for emissions for greenhouse gas. Decisions on specifications about

data centres are vital for cost management, reducing reputational risks, and obtaining a

reliable energy and water supply especially with an increased focus on global regulation on

climate change. Speaking of which Google's data construction centres that utilize 50% of

energy compared to that of an average data centres has resulted in significant savings for the

company (Laura D 2015).

Apart from Google, there are several other success stories across different sectors.

Since 2011 DuPont a US-based company has invested over $879 million in research and

development of products with considerable amounts of environmental benefits. In terms of

revenue, the company has recorded over $2 billion on products that minimize the emission of

greenhouse-gas and extra $11.8 billion of revenue from renewable resources such as wind
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and solar energy. Similarly, between the years 2007 and 2012, Procter and Gamble which is a

multinational consumer good company did report $52 billion on sustainable innovation

product sales (Laura D 2015). This was a representation of 11% of the company's total sales

throughout that period.

It is believed that investing in material sustainability, firms are likely to have an

increase in shareholder value (Almansoori, & Nobanee, 2019). For a company to fulfil its

role to the investors, it ought to consider incorporation of ESG factors to have a material

impact with time (Hassan & Roychowdhury, 2019). This is an incentive that is likely to make

the world work towards a more sustainable future.

There seem to be several valid reasons as to why investing sustainable organizations

get to boost their shareholder's value. The moment a company fulfils its fiduciary

responsibility to its investors; there is a high possibility of going the extra mile and

surpassing its financial returns obligations and incorporating ESG factors (Hassan &

Roychowdhury, 2019). These factors have the potential of impacting positively on

performance with time. Through this not only do investors get relevant corporate reports on

performance measures which prompt them to invest but also sustainable investment is

achieved.

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