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ESG investing has shown steady growth among institutional investors over the past few years but it seems to have reached a turning point during the pandemic. It became very apparent to investors that high-rated ESG funds were surprisingly resilient to the short-term volatilities in the market. Here is all you need to know about ESG in the context of the family office industry.
What is ESG and why is it important for family offices?
Environmental, Social, and Governmental are three umbrella terms used to define various non-financial factors that can be used to identify risk and growth opportunities within sustainable investing. These include:
- Environmental – Policies on the usage of clean energy, conscious waste management, efforts towards achieving net-zero emission norms, and promoting sustainable development.
- Social – Human rights standards, work environment, diversity, inclusivity, equality scores, etc.
- Governance – Compliance standards, corporate accountability, and relationships with stakeholders.
It wasn’t long ago that ESG investing was merely an inspirational term that carried little weight in a family office’s portfolio. However, that changed following the publication of an IFC report in 2005 entitled “Who Cares Wins” which highlighted the positive impact of ESG on long-term sustainability. The shift in perspective on the positive impact that sustainable investing can have on society has already been observed among the next generation of wealth owners. Therefore, aligning investments with family values and legacy goals is another compelling reason for the prioritisation of ESG for family offices and their governance frameworks.
ESG and the next generation
Traditionally, it has been observed that for the current generation of wealth owners, the total return has the most significant impact on choosing an investment. However, it has been observed that the younger generation tends to be more mindful of the impact that their investment would make on society as a whole, or in other words, they tend to invest for a positive ESG impact.
According to experts, ESG and impact investing haven’t yet reached their tipping point. However, with the great wealth transfer already upon us, the next generation of UHNWIs is expected to lead the family office ESG investing revolution. The pandemic has only accelerated this trend and it is evident from the fact that high-rated ESG funds have fared surprisingly well in the extremely volatile post-Covid market.
Nuances within sustainable finance
Despite the seemingly impressive growth of sustainable finance in the last 5 years, they have had little effect in solving the major global challenges. This is because a large proportion of assets managed with ESG criteria are never acted upon to improve or actually have a positive impact on society.
Impact investing adds a new dimension to the traditional risk-return relationship by incorporating financial gain in the form of a positive impact on the planet and/or society. In this strategy, investors can pre-define the ESG impacts that they wish to target and set up an adequate asset allocation by taking into account their existing civil, fiscal, and wealth conditions. Impact investing differs from responsible investing which is only designed to minimise the risks linked to ESG criteria but doesn’t take into account the potential financial gains from such an investment.
How Family Offices Approach ESG
The family office ESG landscape can be explored from three different perspectives:
ESG in impact investing
The quest to incorporate positive ESG standards into portfolios has led to the rise in popularity of sustainable investing among family offices globally. However, unlike the other approaches of sustainable investing that are simply designed to avoid any kind of damaging investment, impact investing is designed to yield both financial and non-financial returns in the form of societal good. Therefore, it can not only be a great tool to improve ESG scores but also a potent vehicle that can generate healthy returns for stakeholders.
ESG in real estate
Real estate has always been a safe asset class to invest in for family offices. However, incorporating ESG standards into real estate portfolios can provide even better long-term stability which has become a key priority among many family offices since it can grant them strategic resilience during periods of volatility like the pandemic. For example, investing in affordable housing projects in Malta can be a great long-term investment since over 20 percent of the Maltese are at risk of poverty and lack basic housing opportunities.
ESG in venture capital
Venture capital is undoubtedly a volatile, high-risk/high-reward industry. However, family offices have begun incorporating ESG criteria while analysing potential VC investments to find sustainable businesses/startups that can serve as reliable partner(s) in the long run. This is all the more important now that ESG legislations are being standardised globally and investing in private companies with high ESG scores has become a necessity to retain stakeholder confidence.
What is an ESG statement and how can family offices draft one?
An ESG statement is a report that contains a company’s disclosures on the impacts that their operations had on the various ESG factors mentioned earlier. The importance of ESG reporting can be inferred from the following reports from an EY survey from 2020:
- 98% of respondents evaluate non-financial performance based on corporate disclosures.
- 91% of investors said that non-financial performance has played a major role in their investments in the last 12 months.
- 75% of respondents said that they’d find value in the assurance of an organisation’s plan to tackle climate risks.
However, despite its rising importance, ESG reports are still non-financial disclosures and are loosely regulated. However, there exist multiple frameworks that define how an organisation’s ESG reports should be published. These most widely accepted ones are the Global Reporting Initiative(GRI), the Sustainability Accounting and Standards Board(SASB), and the International Integrated Reporting Council(IIRC).
Here is a basic overview of an ESG reporting workflow:
- Setting up a board – An ESG board will oversee all the ESG issues that are relevant to the operations of the family office and its revenue-generating capabilities. It will be the job of the board to identify the risks and opportunities that these issues might present and how they can be implemented into the family office’s overall ESG strategy.
- Setting up an ESG working group – The working group’s function is to identify and report on the relevant internal data sources as determined by the board.
- Selecting a suitable ESG reporting framework – The framework will set a clear boundary on what to include and what to omit from the final ESG report.
- Performing a materiality assessment – A materiality assessment can be used to identify the ESG issues that are relevant to the family office and its stakeholders. Material assessments can be performed internally by the senior employees or externally by the stakeholders.
- Preparing the report – The final ESG report must be transparent and auditable and the goals presented in the report must be specific, measurable, achievable, realistic, and time-bound(SMART). It must also comply with the chosen reporting framework and fall within the boundaries defined by the board.
Producing an ESG statement is definitely a time-consuming process and involves heavy data processing and analytics and is, therefore, prone to human error. However, modern ESG software is designed to automate much of this workflow without the need for complex integration with existing systems.
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