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Seeing things differently – the bigger ESG picture

There's a lot more to ESG than just the environment. That's why looking at the bigger picture - at global trends, policy frameworks and unexpected events - is so important to understand the impact on corporate performance.

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The ripple effects of Russia’s war in Ukraine have been sweeping. Beyond the suffering in Ukraine itself, global food and energy price surges have sent millions of people in the developing world further into poverty. The UN reports that after years of decline, hunger and food insecurity are rising once again, affecting 828 million people.

Global trade and investment patterns have been fractured, and businesses from auto manufacturers to clothing retailers have found their industries hampered by supply chain disruptions. Sectors such as energy and defence, on the other hand, are seeing a boom. All this has clear implications for investors—but could they have anticipated these extraordinary developments?
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Social sustainability

“Geopolitics is becoming more complex,” says Leïla Choukroune, Professor of International Law and Director of the Democratic Citizenship research theme at the University of Portsmouth, in the UK.

Choukroune’s main focus is the way human rights and trade interact. She believes these issues are often missed by investors. “Environmental sustainability is well understood, but social sustainability is less understood, and it plays a big part in macroeconomics and the state of the world at the moment,” she says. “While the tragic effects of climate change are well known, other issues—international migration, labour shortages, gender disparity—all these have to be taken into account by investors, as well, because they play a part in the return investors can make.”
Only relatively recently have most investors become accustomed to picking over companies’ ESG plans and track records. More data continues to become available to assess a company’s impact on society, from its carbon footprint to board diversity. But what investors might not fully consider is the potential impact of global trends on the company.
Recent research from PwC shows that 79% of global investors surveyed view ESG as an important factor in their investment decisions. In addition to focusing on ESG from the business perspective, it’s important to combine this data with the influence exerted by macro ESG trends.
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Restricted vision

Analysing only the corporate picture is like “looking at ESG with one eye closed,” says Jeremy Lawson, Chief Economist at global investment company abrdn and Head of the abrdn Research Institute. The micro-ESG approach has prevailed, says Lawson, because of the ESG analysis industry’s historic focus on understanding the risks of investing in individual firms.
“Over time, there’s been a greater appreciation that you also need to understand the big-picture drivers of the environment that influence a company,” he says. “But a lot of the expertise in the industry is built around these micro questions. You need a very different skill set to analyse the intersection between politics, public policy and economics, and how those factors influence both micro and macro investment risks and opportunities. Too few economists and public policy experts worked in the ESG field within the financial sector.
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“All investors understand that the macroeconomic, policy and political environment shape investment returns. But building a framework to incorporate it rigorously into valuation, stock selection and portfolio construction is not straightforward,” he says.

Anticipate the unexpected

Lawson predicts that the ESG sector will evolve in this way over the next five years. He believes abrdn is ahead of the game, developing investment analysis tool that adds a macro lens to all ESG-related data, decisions, and scenario analysis.
This enables the company and its clients to better anticipate the consequences of macro events—even if they appear unlikely. So, for example, while Hillary Clinton was widely expected to win the 2016 US election, abrdn nevertheless spelled out in advance the consequences of a Trump victory, including the effects on international trade and on the US-China relationship, and the types of firm that would be most vulnerable to the changing geopolitical landscape.
A more recent US event that created global ripples is the Biden administration’s Inflation Reduction Act, which aims to catalyse a surge in clean energy investment.
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“Market prices moved a lot in reaction to the passage of that bill, because it wasn’t expected,” says Lawson. “A lot of the securities that did best are those that were identified by our forward-looking tools as being advantaged by the energy transition. It demonstrated the importance of keeping your eye on the long term, because investment opportunities can move a lot when policy eventually moves in the direction that you’ve been expecting.”

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In advance of the Ukraine invasion, abrdn was able to spell out the potential consequences, including the effect on food and energy prices. “By analysing that in advance, using scenarios, you can help people react much more quickly when the unexpected occurs,” Lawson says.

Beyond company performance

To analyse conflict risk in a structured way, a building block in abrdn’s macro ESG index considers and calculates how conflict is measured, and the domestic and international risks of its intensification, allowing for an anticipatory rather than a merely reactive approach.
“Russia is by no means alone in the world in undertaking actions that breach international obligations and treaties,” Lawson points out. “We have to think about that in an objective and systematic way, particularly if we want to avoid unwanted risks that overshadow how individual firms are managing their own ESG risks in exposed countries.”
It’s a colossal task, given that macro ESG issues cover not just conflicts and political events, but also the elements of supply chains, and even more abstract concepts such as the quality of a country’s governance and income equality.
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In some ways, investment itself is a macro vehicle, and potentially a global force for good. “Investors are obviously massive players in the global economy; they can change the world to some extent,” says Choukroune. “They can make a big impact on local communities by investing responsibly.

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“So, it’s very important for investors not to look just at a company’s performance, their profit, their turnover. In looking long term, they can integrate strategic policies and objectives that will pay off.” Capital at risk.

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