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Think of ESG as GPS for a new and shifting landscape.

Environmental, Social and Governance (ESG) investing is more (and maybe less) than you might think. Somewhere on the road from obscurity to prominence, ESG became a catchall term. Unfortunately, by conflating ESG with a broad range of investment strategies, we detract from its own considerable merits and increasing relevance.


Jeff Gitterman, a widely respected thought leader in the ESG and sustainable investing space, provided some clarity about this in a recent episode of The Flexible Advisor.

We took an unexpected turn


Like it or not, environmental issues, social change, and regulatory issues are reshaping society, business, and our lives. Our industry is not exempt. Now we find ourselves trying to move forward with an outdated map and a rusty compass.


“We saw that things were changing, but had no means to measure the financial impact,” says Gitterman. “The problem is that ‘you can’t manage it if you can’t measure it.’ Now, we have this new and increasingly sophisticated dataset to measure and analyze the impact of ESG factors. Now they can be managed, which is staring to happen, and then they will be priced. We think that is not far off.” He offers this current example: “Reinsurers are facing claims at a rate never experienced before. Major rating agencies are acquiring the companies that provide physical risk data. The data is here to understand the risks, and now they can be priced into the market. As a result, we expect a dramatic impact, and soon, in pricing around mortgages, municipal bonds, coastal properties and real estate. The market's kind of had its head in the sand about it, but that's changing quickly.”

“ESG gives you more data to evaluate potential investments. That puts you in a better place to talk with clients about potential routes and their preferences.”

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Given this example, consider the extraordinary implications of data being mined, measured, and managed across the full spectrum of the ESG universe. Plotting a client’s financial journey can incorporate new roads, new accommodations, even new destinations, to enhance the trip or simply smooth the ride.


This is why Gitterman likes to compare ESG to GPS. “It gives you more data than an old map. There is no guarantee that GPS will get you there faster; there are times when a map might beat the GPS. But you have a wider data set to plan your trip. That's what ESG does; it gives you more data to evaluate potential investments. And that puts you in a better place to talk with clients about potential routes and their preferences and then create a well-informed financial map.”


Know when you cross the border


“After evaluating all of the key data for the trip,” he explains, “you can introduce specific ESG datapoints the client might want to include on their journey. For example, they may not want to own fossil fuels. Or tobacco companies. Or weapons. Those requests ought to be discussed if they are a priority. But be clear: you are no longer talking about ESG. ESG is data; it has no opinion or agenda. When you move to applying ESG to address personal values or objectives, you are discussing Impact or Responsible investing or some other strategy.”


We end where we started: ESG is data, and it is becoming essential for anyone wanting to navigate the new realities of investing. Conflating it with terms such as Responsible investing, Impact investing or Sustainable investing creates misunderstanding and, worse, obscures ESG’s much greater scope and importance.

TAKEAWAYS

  • Conflating ESG with other investment strategies detracts from its own merits and relevance.
  • You can’t manage it if you can’t measure it
  • Consider the implications of data being mined, measured, and managed across the full ESG universe.

 

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Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. An ESG investment methodology that includes and excludes issuers and assigns weights to issuers by applying non-financial factors, such as ESG factors, such ESG investment methodology may underperform the broader equity market or other investment products that do or do not use ESG investment criteria. An ESG investment methodology will influence exposure to certain companies and sectors.

Currently, there is a lack of common industry standards relating to the development and application of ESG criteria, which may make it difficult to compare an ESG investment methodology with the investment strategies of other investment products or funds that integrate certain ESG criteria. The subjective value that investors may assign to certain types of ESG characteristics may differ substantially from that of an ESG investment methodology or a data provider.

Not all FlexShares ETFs have an ESG focus. For more information on which FlexShares ETFs have an ESG focus, please visit flexshares.com