ESG Selection of Good Books | Financial Experts' Guidance: How to Address Climate Change and Obtain Exceptional Returns through ESG Investments (Part One)

LINK-ESG Good Book Recommendation Officer in this issue wants to introduce "Sustainable Investing: Beating the Market with ESG" by Hanna Silvola and Tiina Landau. This book details how to identify future business opportunities and manage risks through environmental, social, and governance (ESG) analysis, in order to achieve exceptional returns. The book not only provides academic research results but also practical models and tools to help investors conduct ESG analysis. Tiina Landau is an internationally recognized sustainability expert and a certified European Financial Analyst (CEFA). She currently serves as a sustainability manager at Neste Corporation, integrating sustainability considerations into new business models and supply chains. Previously, she served as Senior Responsible Investment Officer at Ilmarinen, managing investment assets worth 5 billion. She has also worked at OP Financial Group (80 billion of investment assets) and KPMG Management Consulting, with extensive experience in media and seminar speaking engagements. Hanna Silvola is an Associate Professor of Accounting at the Hanken School of Economics in Finland. Her research interests include sustainable investment and measuring, reporting, and assuring sustainability information in strategic decision-making. She has international experience at the London School of Economics, Stanford University, Monash University, and the University of New South Wales, and has published related papers in several accounting journals. This book reviews the latest sustainable investment approaches and financial profitability methods, and describes how ESG analysis can identify business opportunities and manage risks to achieve exceptional returns. The book discusses how major trends such as climate change, sustainable development, and digitization increase uncertainty and asymmetric information, affecting future investment returns. From a profitability perspective, the book mainly explores how ESG factors affect long-term added value for companies and the valuation of companies in financial markets. While sustainability offers opportunities for exceptional returns, this phenomenon also needs to be critically examined. The book describes the risks and limitations associated with the reliability and availability of ESG data and tools. Achieving dual growth of wealth and value, a sustainable investment guide Sustainable investment is an investment concept and method that incorporates environmental, social, and corporate governance (ESG) factors into investment analysis and decision-making processes. Sustainable investment focuses on the long-term sustainable development of companies, aiming to promote economic, social, and environmental sustainability while obtaining good investment returns. The essence of sustainable investment is mainly reflected in the following aspects: 1. Incorporating consideration of ESG factors on the basis of traditional financial analysis. Investors believe that companies with excellent ESG performance are better able to respond to various risks and challenges, creating long-term value. 2. Through ESG information, comprehensively understand the impact of corporate operations on the environment and society, identify potential investment risks and opportunities, and achieve matching and optimization of risk-return. 3. Play a guiding role in capital allocation, directing funds to assets with excellent ESG performance that are in line with sustainable development, and promoting the transformation of the real economy towards green and low-carbon. 4. Establish a responsible investment concept, focusing on corporate responsibility in areas such as environmental protection, community development, and ethical integrity, driving corporate transformation through "active ownership." 5. Practice inclusive finance, serve the United Nations Sustainable Development Goals (SDGs), create positive environmental and social impacts while obtaining financial returns. 6. Meet the value demands of institutional investors and high-net-worth individuals, achieve the unity of investment returns and social responsibility, and gain reputation and brand premiums. Sustainable investment is a synthesis of concepts such as ESG investment, responsible investment, impact investment, and inclusive finance, representing a paradigm shift that balances altruism and self-interest in investment. Through market mechanisms and capital power, it drives the social and economic system towards a fairer, greener, and more sustainable direction, contributing financial wisdom to address the common challenges facing humanity. The logic behind ESG investment: why it is becoming a future trend The rapid development of ESG investment has deep driving logic, mainly manifested in the following three aspects: 1. Consideration of long-term risk-adjusted returns Increasingly, research shows that companies with excellent ESG performance can achieve higher long-term risk-adjusted returns. This is mainly based on: ESG management capabilities are a reflection of corporate governance levels and management quality. ESG-leading companies typically have greater resilience and ability to manage risks, especially performing better in times of crisis. With stricter ESG-related regulations and increasing social awareness, companies with weak ESG risk management capabilities face more lawsuits, fines, restrictions, and other negative impacts, which may damage financial performance and valuation levels. ESG issues represent major trends that affect the long-term development of companies. ESG integration helps investors grasp innovation and growth opportunities brought by sustainable development. Therefore, incorporating ESG factors can more comprehensively evaluate a company's value creation capabilities, and selecting assets with excellent ESG performance may lead to long-term excess returns. 2. Reputation management and avoidance of negative events Institutional investors are trustees of public funds and need to be accountable for their investment behavior. Incorporating ESG into the investment process helps to avoid the impact of negative events related to ESG and maintain brand reputation. Scandals such as environmental pollution, product quality, corruption, etc., can lead companies into reputation and public relations crises, often resulting in a sharp drop in stock prices. Adhering to ESG standards helps reduce the probability of such negative events. With the development of social media and accelerated information dissemination, companies andImproper behavior of investors is more likely to be magnified. ESG investing is a necessity for reputation risk management.Regulatory authorities increasingly require investment institutions to disclose their ESG integration status, and including ESG in investments is also a compliance requirement. ESG investment is an important tool for reputation management and risk avoidance, and is an indispensable "moat" for institutional investors. 3. Alignment of social responsibility and institutional values Fulfilling social responsibility has become a consensus across all sectors, and incorporating ESG principles into investment decisions is an important way for the financial industry to respond to social demands. Responsible investment is the value pursuit of large asset owners, especially sovereign wealth funds, pension funds, etc., who need to use entrusted funds wisely to create long-term sustainable value. As wealth transfers to younger generations, the group of investors focusing on corporate social responsibility and values continues to grow. ESG investments help meet the preferences of these beneficiaries and gain recognition. Incorporating social responsibility into investment decisions is an important step for financial institutions to demonstrate their "corporate citizenship" image and enhance brand premium. The mainstream development of ESG investments has its inevitable logic: based on considerations such as long-term value creation, reputation and risk management, and social responsibility. Recognizing and understanding these driving factors is crucial to successful ESG investing. Looking ahead, with the continuous evolution of ESG-related policies and practices, the market's preference for sustainable development will only strengthen, and the acceptance and influence of ESG investments will continue to rise. Key to ESG practice: the three gates of shareholders, board of directors, and management Shareholders' meetings, boards of directors, and management are the three pillars of corporate governance and the main leverage for investors to exert influence and drive corporate transformation. Below, we delve into how investors can practice "active ownership" through these three levels to promote the sustainable development of invested companies. I. Shareholders' meetings: Advocating ESG issues through voting rights Shareholders' meetings are the highest decision-making body of a company and an important platform for investors to exercise their rights. Here are some common practices: 1. Attend shareholders' meetings and participate in voting. Support proposals that enhance ESG performance and oppose motions that contradict sustainability principles. 2. Submit ESG-related shareholder proposals. Advocate for enhanced disclosure, improved corporate governance, emissions reduction commitments, etc., to guide companies to prioritize ESG management. 3. Speak out publicly and express concerns about specific ESG issues to create reputation pressure and urge companies to take action. II. Board of Directors: Supporting the enhancement of ESG governance The board of directors is responsible for formulating the company's development strategy and supervising the management. The following measures can help promote the board's focus on ESG issues: 1. Support the nomination of board candidates with ESG backgrounds to bring sustainable development perspectives into the board. 2. Hold closed-door meetings to communicate with board members, raise their awareness of ESG, and explain the business value of ESG integration. 3. Advocate for the establishment of specialized bodies such as ESG committees to mainstream ESG factors in company decision-making and strengthen board oversight. III. Management: Deepen practical cooperation The management is responsible for implementing the company's ESG strategy. Interaction between investors and management is crucial for advancing ESG practices. 1. Hold closed-door meetings to receive comprehensive reports from management, assess the current status of ESG risk management, and offer specific improvement suggestions. 2. Conduct targeted interviews to discuss specific ESG events (such as supply chain management, product quality, etc.) with management and urge them to make improvements. 3. Conduct on-site visits to investigate the actual operation of ESG management in the company, understand the views of frontline employees, and assess the level of implementation of ESG commitments. 4. Publicly recognize companies with outstanding ESG performance to set benchmarks and inspire management to make greater progress through the power of example. Through these three leverage points of shareholders' meetings, boards of directors, and management, investors can fully and deeply engage in corporate governance, promote the mainstreaming of ESG issues in company decision-making. At the same time, investors should differentiate their approaches and act according to the specific circumstances: companies with shortcomings in ESG risk prevention should be given targeted "diagnosis and treatment"; while companies that already set industry benchmarks in ESG performance should be positively encouraged to grow and strengthen. Investors need to engage in candid and practical dialogues with investee companies, understand their needs, provide professional advice, and work together in order to achieve the best results. Stay or go! How investors can use "exit" to stimulate ESG actions by companies In addition to softer approaches such as interactive communication, investors can also use the "voice" and "exit" strategies to urge investee companies to pay attention to ESG issues and promote sustainable transformation in a more forceful manner. I. "Voice": Criticize and hold accountable, create pressure "Voice" refers to publicly expressing dissatisfaction, exerting pressure on investee companies, and forcing them to address ESG risks and improve ESG performance. This can include: 1. Public statements: Express concerns about the company's inappropriate behavior in ESG areas through open letters, media statements, etc., and demand explanations and deadlines for improvement. 2. Dissatisfied voting: Vote against or abstain from voting at shareholders' meetings to hold companies accountable for their inaction on ESG issues. 3. Submit proposals: Propose resolutions as a shareholder on poorly managed ESG issues, seek support from other shareholders, and use resolutions to pressure the company. 4. Form alliances: Collaborate with other investors in joint actions, collectively address the board of directors or management, and exert pressure using the collective wisdom of the group. The key to the "voice" strategy is to be resolute, show determination, and demonstrate a strong commitment to driving reform. For companies that refuse to change, consider gradually escalating measures and, if necessary, resort to the media to amplify social impact. II. "Exit": Inspire and drive change "Exit" refers to reducing holdings or selling stocks as a way to urge investee companies to pay attention to ESG issues and drive sustainable change. Give me something to 'Exit' refers to using the two methods of 'voice' and 'exit' to firmly pressure investee companies to focus on ESG issues, and promote sustainable reform.The way to say "no" to companies with poor ESG performance, to provide negative incentives for them to transform and upgrade. The main idea is: Investor's Guide: Key Tools for ESG Ratings and Disclosure Identifying and evaluating a company's sustainable development factors in environmental, social, and corporate governance (ESG) is the foundation for conducting ESG integration and optimizing investment decisions. This requires utilizing various sources of information and analytical tools. Let's comprehensively assess and understand these tools.Tools for organizing and comparing.ESG: 1. ESGESG 2. ESG 3. ESG ESGBased on the model, customized valuation methods with unique characteristics are developed to assess the financial impacts of ESG factors, such as:1. Adjusting discount rates in DCF models: Adjusting the discount rate based on ESG performance to adjust the risk premium for companies with excellent ESG ratings. 2. Introducing ESG indicators in relative valuation methods: Introducing key ESG indicators related to the industry in valuation multiples such as P/E ratios, such as carbon intensity. 3. Considering ESG risks in option pricing models: Incorporating ESG risks into option pricing models to assess their impact on company value. 4. Simulating ESG changes in scenario analysis: Conducting sensitivity analysis for different ESG scenarios (such as carbon pricing, rising raw material prices). Considering ESG factors comprehensively ESG factors are complex, with positive and negative impacts. Investors need to consider the overall ESG performance of companies before making decisions, such as: 1. Balancing the relative importance of ESG factors: Considering the importance of various ESG factors based on industry characteristics and the company's development stage. 2. Evaluating the dynamic trends of a company's ESG performance: Analyzing the changing trends in a company's ESG performance rather than just relying on static performance at a specific point in time. 3. Incorporating a company's ESG response measures: Analyzing the strategies adopted by a company to address ESG risks and seize ESG opportunities and evaluating their effectiveness. Valuing ESG investments is about tailoring them to individual companies and dynamically iterating. On one hand, customized valuation tools should be developed based on industry characteristics and company attributes; on the other hand, valuation assumptions should be dynamically adjusted to respond to changes in ESG trends. For companies with frequent negative ESG events and a lack of sincerity in remediation, valuations should be decisively reduced; while ESG leaders who are proactive and innovative should be given valuation premiums. Only by continually upgrading the analysis framework, dynamically iterating valuation methods, can one keep pace with ESG developments and provide accurate guidance for investment decisions. Building ESG investment portfolios: From integration to influence in four steps In addition to conducting ESG assessments, investors also need to consider how to integrate ESG factors into portfolio construction to form investment strategies with ESG characteristics. Specifically, this can be achieved through ESG integration, standardized screening, thematic investments, and positive influence. 1. ESG Integration ESG integration involves systematically considering ESG factors in the investment analysis and decision-making process, typically including: - Avoiding or underweighting industries with prominent ESG risks at the industry allocation level. - Selecting preferred targets with high ESG ratings at the stock selection level and avoiding targets with low ESG ratings. - Giving higher weights to holdings with excellent ESG performance at the weighting allocation level. - Embedding ESG factors in optimization of portfolios, such as controlling the weighted average ESG rating above the benchmark. 2. Standardized Screening Standardized screening involves using specific ESG standards to eliminate undesired elements when constructing investment portfolios, including: - Negative screening: Eliminating companies whose business conflicts with investor values, such as tobacco and gambling, from the investment scope. - Standard screening: Eliminating companies that violate internationally recognized ESG standards, such as the UN Global Compact, from the investment scope. - Positive screening: Including the best-performing companies in ESG within each industry in the investment portfolio (Best-in-class). 3. Thematic Investments Thematic investing involves building an investment portfolio around specific ESG themes, focusing on companies that excel in that theme. Common ESG investment themes include: - Environmental themes: Clean energy, green building, pollution control, water resource management, etc. - Social themes: Community development, educational opportunities, healthcare, affordable housing, etc. - Governance themes: Diversity, inclusion, business ethics, etc. Some thematic investments adopt strategies that actively explore potential stocks, such as investing in clean energy companies in the early stages of low-carbon transformation; others focus on leading companies with growth potential and ESG attributes. 4. Positive Influence Positive influence strategies aim to encourage companies to strengthen their ESG practices and create positive impacts through capital allocation. Specific tactics include: - Engagement: Directly engaging with corporate management to drive their focus on and remediation of ESG weaknesses, and to stimulate ESG potential. - Shareholder voting: Voting in favor of beneficial ESG issues and against unfavorable ESG issues at annual shareholders' meetings. - Capital allocation: Establishing ESG-themed funds and directing investments towards companies making outstanding progress in ESG issues. - Collaborative interaction: Forming a "tide of ESG participation" with like-minded investors to drive corporate transformation. Of course, there are other pathways for combining ESG factors with portfolio construction, and investors should adapt accordingly. In practice, it is important to: - Understand your preferences and appropriately position yourself. Assess your ESG investment preferences, evaluate execution capabilities carefully, and find a balance between ideal goals and practical conditions. - Gradually progress for long-term success. ESG investing should progress from superficial understanding to thorough integration, and then to distinctive strategies, starting with easy tasks and maintaining persistence. - Innovate mechanisms and optimize models. Continuously review and reflect on practices, adapt to market changes and enhance capabilities to continuously iterate and optimize ESG investment portfolio construction models. ESG factors inject new ideas and vitality into portfolio construction. Investors should embrace change with an open mind, find the most suitable balance between different strategies that align with their capabilities, and develop a unique and effective sustainable investment approach. (ESG Champion link YoungEasyStar)