We might be a long way from an active Generation Alpha but in an increasingly turbulent world, it might pay to stay ahead of the curve. Born during or after 2010, Generation Alpha will be one of the largest “buyer pools” that will dominate the markets after Generation Z. With an expected 2+ billion people buying and selling by 2025 – and although currently very young – the trends of their likes/dislikes are already apparent.
Marketers are urged to take Generation Alpha’s characteristics into consideration from now when they create, market, and sell their products so that they find themselves at the right side (the buying side) of these “mini millennials”, when the time comes.
Some of the characteristics of Generation Alpha are:
- Environmentally and socially conscious
- Technologically savvy
- Brand aware
- Interactive/prefer to be part of an experience rather than be labelled “buyers
With that in mind, today’s topic will focus on the ESG side of investing which covers a great deal most of what Generation Alpha is conscious of. With one foot in a portfolio of assets and one foot out, ESG investing has been a matter of discussion and controversy among piers for years. Do corporations align their strategies with ESG standards as part of a smart marketing approach a.k.a. greenwashing? Do they bring up ESG only to cover for poor performance? Or do they really work towards making a positive impact?
What is ESG investing?
Looking into factors other than a company’s financials, when choosing your investment vehicles. ESG stands for Environmental (carbon footprint, water usage and waste, recycling), Social (employee training, customer service, social justice) and Governance (Board and management diversity, corruption, executive compensation) and it’s the result of various past attempts towards sustainable investing. Not taking enough steps towards sustainable investing, poses risks that although might not affect the short run, could expose a company to future threats. An ESG score/rating is assigned that indicates where a company stands in its ESG efforts.
In 2021, MSCI rated Microsoft with a AAA score (more on MSCI ratings below), the highest rating they can assign. Microsoft’s energy conservation efforts are admirable, with a target of 100% renewable energy use by 2025.
What is an ESG rating?
ESG ratings zoom-in to risks not considered when looking into a company’s financials. Operational and potential litigation costs are part of those risks.
MSCI ESG Research LLC, has been rating companies based on ESG characteristics since 1999. Their rating ranges from worse – CCC/B a.k.a Laggards – all the way to best – AAA/AA a.k.a. Leaders – with average ratings of BB,BBB, A. Other ESG rating companies are RobecoSAM, which was acquired by S&P Global at the end of 2019, Bloomberg ESG Disclosures, Moodys ESG Disclosures, Refinitiv, Sustainalytics ESG Risk Ratings and many more.
Companies with a high ESG score across the board (provided by more than 2 rating companies) include Microsoft, Taiwan Semiconductor, NVIDIA, Adobe. Average score examples across the board include Visa, Mastercard, LVMH (France).
Rating companies, score differently ESG efforts. For example LVMH – Luis Vuitton, a luxury goods conglomerate founded in 1923, gets Average scores by Refinitiv and MSCI but a very low score from Sustainalytics. Amazon gets excellent scores from Refinitiv but average from MSCI and Sustainalytics. All rating companies have a white paper outlining their methodology and investors can tap into them to get the information they need.
If ESG is a good thing, why the controversy?
With religious roots more than anything, the way of – Ethical Investing – attempted to keep people away from “wicked” assets that represented the likes of alcohol, tobacco, weapons, gambling etc. Socially Responsible Investing (SRI) became more prominent during the 70s and 80s as values-based negative screening basically told investors not to invest in a company that conflicts with their values.
As the Vietnam War came to an end, companies were still profiting from its after math. And as SRI investment pushes an industry rather than pull, religious investors steered clear from portfolios that profiteered from the war, continuing the ethical investment initiative.
The Pax World Balanced Fund provided an alternative investment vehicle and various movements/legislative acts went live relating to discrimination and environmental protection. Based on the Sullivan principles of supporting human rights, equal employment opportunities and social programs, from the year 2000 onwards ESG got more push by the United Nations who tried to integrate it into the Capital Markets.
Debates over the years relative to the social responsibility of companies date back to the 70s and include Milton Friedman’s “The social responsibility of business is to increase its profits”. A socially responsible act is one the corporate executive makes, not the business in its entirety. A socially responsible act would mean spending the money of the executive’s employers (shareholders) for a general social interest.
Examples in Friedman’s approach include spending large amounts of money to reduce pollution beyond the interest of the shareholders, hiring hardcore unemployed (hardcore: people jobless for a long time) rather than qualified personnel to help reduce poverty, refrain from raising product prices to help combat inflation (even if a rise is in the best interests of the business).
In all of the above examples, although the executive’s decision represents the business as a whole, spending someone else’s money for a general social interest might come in conflict with why the executive was hired in the first place. The employee acts as a civil servant although works (and is paid by) a private corporation whose interest, is maximizing returns.
According to a Harvard Business Review in March 2022 – referencing an analysis on Morningstar’s sustainability rating of more than 20,000 mutual funds – it was obvious that the highest rated funds attracted more capital, but none outperformed the lowest rated funds. Through studies they also found that to cover for earning’s underperformance, company executives often publicly talked about their focus on ESG (in contrast with overperforming results with little to no reference to ESG). An outright shoutout to investors, who might be investing in underperforming companies in an effort to support their ESG values. Last but not least, studies detected no improvement in ESG scores over a period of time indicating that the financial sacrifice funds potentially undertake for ESG investing, does little to nothing to improve the “wickedness” in the world.
Not all underperformers are created equal
NVIDIA is an example of a high ESG rated stock currently underperforming, but due for correction. A graphics processing unit (GPU) manufacturer, NVIDIA is a AAA rated company. Its GPUs are used for gaming, self-driving cars, and they power the fastest supercomputers in the US and EU. They are also used for mining crypto that use the PoW consensus protocol. Post the Ethereum Merge and the transition to PoS, a reported “unintended consequence” is the drop in sales of new GPUs, since the existing ones that powered the mining equipment will no longer be needed, and will flood the market with second hand/cheaper options.
Combined with US government restrictions on the company selling its A100/H100 products to China, it all resulted in a drop of NVIDIA’s stock price. Although due for a few challenging quarters, its an example of a AAA rated company, a leader in ESG standards that treats people fairly, socially conscious both internally and externally with its suppliers taking a hit nonetheless, ultimately affecting the returns of its shareholders.
That being said, investors are looking at the price drop as a way to enter rather than exit. Cathy Wood’s ARK Innovation Fund ETF sold a small portion of the fund’s Tesla shares in the beginning of the month, to fund a new purchase in NVIDIA ($32 million worth of it), after the sales restriction announcement and a +7% drop in its price.
What about other ETFs?
From $5 billion in 2006 to $378 billion in 2022, the allocation of assets with ESG standards to ETFs saw a significant rise. The largest Exchange Traded Fund in 2022 is SPDR Bloomberg SASB U.S. Corporate ESG UCITS ETF. Its size reached $6.75 billion. iShares ESG MSCI EM ETF reached $6.51 billion.
The question remains. If you have to choose between strong returns on your investment Vs doing something good i.e. ESG investing with less ROI, what would you choose? Sustainalytics research talks of a 40% – a significant percentage of investors choosing ESG investing and accepting a lower ROI. This leaves a 60% that is not willing to take a pay cut.
New information comes out daily regarding ESG investing. Major world events shaped the world as we know it today and people’s conscious efforts towards forging an even better one, generation to generation is a testament to how powerful connected voices can be. Mini millennials will inherit – a better or worse – world than their predecessors, and they are the future consumers/investors. Their exposure to technology from a young age, awareness of the environmental dangers, their pickiness in choosing the “right” brand, the social lessons they pick up from the world stage relating to discrimination, equality and human rights are in the core of what ESG is all about. Remains to be seen, what they’re willing to do with their superpower.
#minimillenials #genalpha #esginvesting #esg #futureinvestors
The information provided is strictly for informational use and is not meant in any way to be construed as investment advice. One should seek expert advice, as all as investment strategies involve risk of loss.