Raymond Greaves, Head of Research at finnCap shares his advice on how to achieve strong ESG credentials and be able to prove it. As we all know, the pandemic has wreaked havoc on the global economy, initially sending global markets into freefall before a slow but steady recovery. However, the crisis has also sparked a renewed interest in long term investments in companies that have a strong stakeholder model that not only works for owners and shareholders, but one that caters to environmental, social and governance (ESG) issues, too.
This trend is also supported by the greatest generational transfer of wealth we’ve seen. In the UK alone, over the next 30 years, £5.5 trillion in assets will shift from baby boomers to the millennial and gen z demographic who are increasingly calling for companies to demonstrate the positive impact they have on wider society. It therefore comes as little surprise that from January to September this year stocks at the top of Fidelity’s ESG ratings outperformed the wider market in all months except April.
As a consequence, a company looking to secure and maintain investment, regardless of industry, must have strong ESG credentials and, just as importantly, be able to prove it. Over the last few years large cap companies have been able to achieve this second objective more easily than small and midcap firms. There already exist numerous ESG rating agencies, each with slightly different weightings and measurements – MSCI, FTSE Russell, Sustainalytics and the S&P all have their own variations. All use measurements suited to the framework of large companies that have the resources and data to present full results.
Smaller firms with fewer links in their supply chains and less measurable data would find it difficult both to see how they measure up in the first place with regards to ESG objectives, and also to prove them in a clear and comparable way.
A toolkit that aids investment in SMEs
Carrying out a survey of small cap fund managers and conducting initial tests on 102 companies, finnCap has developed a scorecard that small and mid-cap firms can more easily participate in to see how they perform, where they need to improve and to demonstrate their credentials. Cutting through often complex measurements that can skew ESG figures, the toolkit is divided equally into 15 component parts, with five each for every cornerstone of E, S and G factors. They are listed below:
- Energy Intensity
- CO2 Intensity
- Water Intensity
- Waste Intensity
- Presence of an environmental or sustainable policy
- Employee turnover rate
- Percentage of profits paid in taxes
- Presence of a discrimination policy
- Presence of a community outreach policy
- Presence of an ethics policy
1. Percentage of women on the board
2. Percentage of independent directors on the board
3. CEO pay as multiple of UK median pay
4. Is CEO and chairman role split
5. Adherence to a relevant corporate governance code
Amid increasing scrutiny across all factors of ESG measures, the scorecard’s equal weighting provides companies with a clear pathway as to how they can improve their overall score, making sure not to neglect any individual element. From initial results, this is highlighted by companies in the support services industry. They outranked companies from the tech, industrial and consumer industries when measured environmentally and outranked companies in the tech, consumer, financial, life sciences and energy industries when measured against social factors.
However, they came fourth out of five industries overall purely as a result of a weak performance in governance measures – fewer than 50% of the sector’s board directors are independent and the proportion of female directors on boards is only 14%.
Having a balanced performance across all categories should be of paramount importance as feedback from fund managers highlighted that whilst governance considerations have been examined for years now, social and environmental concerns are increasingly coming into the spotlight.
From an investment perspective, a positive scorecard result enables those looking to take a position in a company to do so with confidence, knowing they are getting the full and clear picture. Not only is there a sea change towards ESG investment, but it is important to note the way in which it is being conducted. Tracker funds now make up 18% of total ESG investment – meaning that a significant amount of money is passively invested in companies that can in some way numerically quantify their ESG status rather than in those being individually hand-picked.
When examining the wider picture and seeing that global assets in sustainable funds have hit £930 billion, or that inflows into ESG funds have quadrupled in the three quarters of this year (£7.1bn compared to £1.9bn over the same period last year), it becomes apparent that companies must not only look to improve their ESG credentials, but make sure they have the means to easily package the results into data that makes it easier for a fund, or even fund tracker to pick up – rather than merely demonstrating ESG credentials in investment reports.
About the Author
Raymond Greaves is head of Research at finnCap, A broker and adviser that provides an unrivalled range of financial services and growth financing options to the UK’s most ambitious growth companies, ranging from ECM, IPO, debt advisory and PLC strategic advisory. finnCap also houses a market-leading strategic M&A firm, Cavendish Corporate Finance, that specialises in mid-sized businesses with a global reach. finnCap serves 117 companies on AIM and on the LSE Main Board, as well as a range of private businesses, helping them find the right investment for growth.
Founded in 2007, finnCap merged with Cavendish Corporate Finance and listed on the AIM market in 2018, and the group has helped raise over £2.8bn to support its corporate clients and sold over 600 businesses.