Why ESG remains a priority for companies and investors

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What do climate and diversity have to do with investing? For Priti Shokeen, the answer is simple: a lot.

“Six or seven years ago, I could cite examples of companies that denied climate change is a business risk,” says Ms. Shokeen, head of Environmental, Social, and Governance Research and Engagement at TD Asset Management Inc. (TDAM), one of Canada’s largest asset management firms. “Now we live in a world where many companies are proactive on their ESG performance.”

Ms. Shokeen views part of a company’s success in terms of how its business model affects the environment and society, and vice versa. She says ESG factors will likely gain more prominence and become a standard part of corporate disclosures in the years to come.

“There’s an increased level of disclosure expectations around ESG that didn’t exist before, and companies need to navigate all of that,” Ms. Shokeen says. “Stakeholders are increasingly asking for this information, whether employees, shareholders, the communities in which companies operate, or consumers at large. For some stakeholders, it represents a strategic shift in thinking about risks and opportunities more holistically.”

Several developments stand to shape ESG investing this year, according to Ms. Shokeen.

She expects that geopolitical situations will continue to weigh heavily, noting that Russia’s invasion of Ukraine has had an impact on everything from gas prices to stock markets.

In 2021, Russia supplied more than half of Germany’s natural gas. Those flows have been cut steadily. Investors will want to monitor how governments respond to concerns around energy shortages and climate change goals, how the conflict has hit other commodities hard, and the impact on various sectors and companies. What’s happening in Ukraine underscores the range of influences at play for ESG investing.

“The conflict brought into focus underinvestment in energy, which, for some countries, has pushed the conversation on energy transition and security further,” says Ms. Shokeen.

In Canada, another consideration for investors is the expected increase in production of sustainable assets following the enactment of the Canadian Net-Zero Emissions Accountability Act. The goal of the legislation, as well as similar developments in other countries, is to achieve net-zero emissions by 2050.

In addition, the federal Sustainable Finance Action Council released its Taxonomy Roadmap Report in March. It featured a made-in-Canada framework for developing a new system for categorizing financial investments or assets. This taxonomy includes definitions for “green” and “transition” investments, creating clarity for capital markets that are actively seeking sustainable investment opportunities. The framework is key to aligning capital flows with Canada’s climate targets and economic opportunities.

Ms. Shokeen notes that solar and wind energy are now more cost-competitive with traditional sources of energy. However, “traditional sources and related infrastructure are not fully replaceable yet, and grid stability and overhaul in terms of clean sources of baseload energy remains a work in progress.”

Something else to watch is the trend away from divestment and toward transition to a low-carbon economy. In the past, Ms. Shokeen says certain ESG-focused fund managers divested from oil-and-gas production companies. Now, such fund managers and investors seem to be more focused on an orderly shift from oil-and-gas to the production of renewable and less carbon-intensive energy sources such as wind and solar.

“ESG-focused retail and institutional investors are realizing how they can use their investing power to influence change and benefit from opportunities arising from energy transition and clean economy transformation. We’re now seeing a huge shift where traditional oil-and-gas companies are increasingly allocating billions of dollars to clean technologies and renewables. This underscores the need for staying engaged with companies in this sector,” Ms. Shokeen says.

Diversity driving economic value

Beyond the environment, ESG factors such as human capital factor into investment opportunities.

The pandemic has affected the nature of the workplace in ways that are still emerging. We’ve seen labour shortages and, according to studies by McKinsey and Forbes, women have exited the workforce in numbers not seen for years. The right workforce makeup is critical, as diversity and inclusion are an important part of ESG and are recognized as a contributor to financial success, Ms. Shokeen says.

“There’s a common understanding now that diverse backgrounds and experiences can help drive innovation, progress and economic value for a company.”

This is something institutional investors are serious about and is reflected in their proxy voting guidelines. For instance, a number of large Canadian asset management companies and pension funds have guidelines related to withholding votes from directors if boards have less than 30 per cent women.

Driving change through voting is moving the needle in boardrooms, even if progress is slow. As of 2021, 33.9 per cent of board seats for TSX60 companies were held by women, though that number drops to 23.4 per cent for all TSX-listed companies.

At a systems level, looking beyond traditional financial indicators and adding ESG factors can provide a more holistic evaluation of long-term themes that may impact portfolios, says Ms. Shokeen. At an individual security level, investors and asset managers can also gain a better measure of a company’s outlook.

The higher quality and quantity of ESG data now available offers more choice to investors. ESG-related funds can provide competitive returns, subject to other market conditions, adjustments and factors that may impact performance. Ms. Shokeen says there is a growing appetite for such funds¹ ².

“When companies disclose their ESG risks more systematically, investors will be more equipped to make informed decisions,” she says.

Advertising feature produced by Globe Content Studio with TD. The Globe’s editorial department was not involved.