Hype is a powerful driver of human behaviour. History is full of examples of fads that masqueraded as solid investments, leading people to decisions based on fear of missing out, rather than cold, calculated facts. When it comes to fad investing, non-financially savvy clients are especially at risk of being taken in. Were it not for the adviser being there to act as the voice of reason, they could easily be swayed by beer-and-tongs brandishing self-proclaimed “experts” or distracted by exciting promises and glitzy marketing.
In an article for Allan Gray, Dan Brocklebank, head of UK operations at Orbis, put it succinctly: “Human emotions and instincts can be contrary to sound investing. Our instincts often pull us in the opposite direction to what we need to do to succeed at investing,” he wrote. “We need to internalise this and factor it into how we invest. Having a clearly articulated plan and approach can help moderate emotional responses.”
He goes on to advise exercising caution when new things come along, and to beware bubbles, citing profitless technology companies as an example.
So, when it comes to assessing an investment or investment strategy it is, naturally, important to distinguish between fad and trend. Both can generate hype, but according to Investopedia’s definition, “trends persist over the longer term and are usually based on fundamentals, whereas fads usually die down after a shorter period.”
ESG (environmental, social and governance) investing, also known as sustainable or responsible investing, has been getting a lot of attention in recent years. Its rise in popularity coincides with a general societal focus on these issues, particularly by younger people. Is that a red flag for a fad or is it part of a broader trend?
A brief history of ESG
ESG investing is a kind of investment activism, allowing investors to put their money in companies that align with their values, while also holding businesses to account. Such investors are looking to put their money in companies that actively seek to minimise their environmental impact (E), exercise social responsibility (S) and have ethical governance practices (G).
While the concept of holding business to account is not new, ESG first became “official” when the United Nations launched the Principles for Responsible Investment in 2006. Then-UN president Kofi Anan said at the time, “These Principles grew out of the understanding that while finance fuels the global economy, investment decision-making does not sufficiently reflect environmental, social and corporate governance considerations – or put another way, the tenets of sustainable development. Developed by leading institutional investors, the Principles provide a framework for achieving better long-term investment returns and more sustainable markets. I invite institutional investors and their financial partners everywhere to adopt these Principles.”
The Principles were crafted by a group of 70 experts, and more than 20 pension funds, foundations, and special government funds around the world. They were signed by heads of leading institutions from 16 countries, representing more than US$2 trillion (remember, this was in 2006). So, it’s safe to say, then, that ESG does not meet the criteria for being a fad.
“ESG is not a fad but rather represents a new age for the insurance industry,” notes Guy
Chennells, head of product at Discovery Employee Benefits. “ESG has gained significant traction and relevance in recent years as companies across various industries, including insurance, have recognised the importance of sustainability and responsible business practices.
“Insurers are increasingly integrating ESG factors into their investment decisions, underwriting practices, product offerings, and risk management strategies. They are aligning their businesses with sustainability goals, promoting social responsibility, and adopting governance practices that ensure transparency and accountability. ESG has become a crucial part of the insurance industry’s transformation and response to emerging societal and environmental challenges.”
ESG in South Africa
Interestingly, South Africa was a pioneer of the principles of ESG investing, albeit not officially or in so many words. In an article in Acumen, the magazine for the Gordon Institute of Business Science, Anne Cabot-Alletzhauser, the practice director: responsible finance initiative at GIBS, points out that environmental impact first became a concern in South Africa in the 1970s, particularly focusing on the mining, oil and gas sectors. Governance issues entered the spotlight post-apartheid, when South Africa was looking to re-establish trust with international markets. And the JSE launched its Socially Responsible Investment index in 2004.
Viewed in such contexts, it’s evident that ESG is not just an example of virtue signalling, nor a box-ticking exercise – it has real, practical implications. “ESG matters significantly for the insurance industry, and its importance is expected to grow further,” says Chennells. “The environmental, social, and governance factors have wide-ranging implications for insurers, such as:
Risk management: ESG factors can help insurers better understand and manage risks associated with climate change, natural disasters, social unrest, governance issues, and ethical concerns. Incorporating ESG analysis into risk assessments allows insurers to make informed decisions and mitigate potential losses.
Sustainability: Insurers play a critical role in society by providing protection against risks. Demonstrating a commitment to ESG principles helps build trust among customers, employees, regulators, and the broader community. It can enhance the insurer’s reputation and contribute to long-term sustainability.”
The tricky part of ESG is balancing the different aspects. As pointed out by Mike Adsetts, Deputy Chief Investment Officer at Momentum Investments, in this very publication, “one of the challenges of ESG is that the three different components sometimes do not align and in other cases pull in opposite directions.” He recommended a nuanced approach – for example, investing in renewable energy, but also in (government guaranteed) Eskom bonds to support energy security, which is imperative for economic growth.
“Balancing the E, S, and G in ESG requires a comprehensive and integrated approach,” agrees Chennells.
“Environmental (E): Insurers can focus on reducing their environmental footprint by managing their own operations sustainably, promoting environmentally friendly products and services, and integrating climate risk assessments into underwriting practices. They can invest in renewable energy projects, support environmentally conscious initiatives, and develop insurance products that incentivise sustainability. At Discovery Insure, our Corporate Social Investment team launches multiple environmental initiatives such as environmental awareness days during which employees participate in activities such as recycling, planting of trees and clean-up campaigns.
Social (S): The social aspect of ESG involves addressing social issues such as diversity and inclusion, client welfare, employee well-being, community development, and ethical conduct. Insurers can prioritise fair treatment of policyholders, employee diversity and inclusion, support for local communities such as Pothole Patrol, a shared-value initiative between Discovery and partners to improve road infrastructure in South Africa, and responsible product development to meet client needs.
Governance (G): Governance encompasses transparent and accountable business practices, risk management, ethical behaviour, and board oversight. Insurers can establish strong governance frameworks, ensure effective risk management and compliance, maintain integrity in their operations, and actively engage with stakeholders. Discovery Insure is audited by external auditing firms to ensure transparency, accountability and regulatory practice are met.”
He adds that striking the right balance is not an off-the-shelf solution – it needs to be specific to each business. “Achieving balance requires a strategic approach, tailored to the insurer’s specific circumstances and industry context. It involves setting clear goals, developing policies and procedures, embedding ESG considerations into decision-making processes, measuring performance, and regularly reporting on progress.
Collaboration with stakeholders and continuous improvement are vital to ensuring meaningful impact and driving positive change across all ESG dimensions. Society is a fundamental pillar of the Discovery Shared-value Insurance model, forming an integral part of our approach to ESG initiatives and development. This holistic approach, combined with Discovery’s core purpose – to make people healthier and to enhance and protect their lives – are the building blocks for a greener future.”
Talking ESG with clients
Ultimately, as with everything, the discussion around ESG investing comes down to what’s best for the client. Being able to help a client align their investments with their personal values demonstrates respect and understanding of the client, strengthening the relationship and building trust. However, advisers also need to be that voice of reason and help the client make decisions that will not only sit well with their conscience, but also secure their financial future.
ESG conversations can take various forms and need to be tailored to the individual client. Investopedia notes factors that should be taken into account include the client’s goals, their personal values, beliefs and priorities. Some clients may be drawn to certain ESG aspects more than others. So, a client who prioritises environmental issues would have different requirements to a client with a strong affinity to social issues, for example.
Then, there’s the matter of due diligence. As with anything, there’s ESG and there’s ESG. An article in Harvard Business Review last year cited research out of Columbia University and London School of Economics that unearthed a worrying finding: US companies in the 147 ESG portfolios they analysed had worse compliance records for both labour and environmental rules compared with companies in 2 428 non-ESG portfolios. This was in addition to University of Chicago researchers finding that none of the highly rated sustainable funds they analysed outperformed funds that rated low on sustainability. This underscores the need to help clients make decisions based on facts and research.
ESG investing may sound like a complex topic to navigate, and it certainly has many components that need to be taken into account. However, when all the noise is stripped away, it comes down to fundamentals: taking time to get to know the client, putting their interests first, and making carefully considered decisions, based on facts.