SINGAPORE (Sept 20): Investing on Environmental, Social and Governance (ESG) principles is a niche area of financial markets that is gradually becoming mainstream, says Nina Hodzic, an ESG specialist at NN Investment Partners.

Hodzic who visited Singapore earlier this month for a conference on responsible investing, says investors who dismiss ESG as a viable strategy may not just miss profitable opportunities but warning signs of investing pitfalls in companies with shortcomings in ESG compliance.

“In the past, this space was more about excluding (undesirable) sectors like tobacco or nuclear energy, but now, it has shifted more into looking at the opportunities from an ESG perspective,” she explains. “So, when we look at companies, we look into their ESG policies, whether they have management systems in place, how they perform from an ESG perspective or whether there are any big issues or controversies.”

She cites the examples of BP and Volkswagen (VW) as two companies whose deficiencies in ESG compliance raised red flags for investors. Before BP suffered its worst environmental debacle in 2010, the oil major also had a higher-than-average incidence of oil spills compared to its peers.

The warning signs at VW were more subtle but investors scrutinising their ESG practices would have probably shied away from buying its shares. “While there were no signs on the environmental side — which would have been difficult to find out anyway - there were quite a few issues from a governance perspective,” she observes, pointing to deviations from corporate best practices at the company.

“At one point of time, there was even a board member whose young wife was an employee of the company. There were also internal issues about composition of the board members and how they worked together,” explains Hodzic. “While these were not huge issues, they were significant enough to warn us that VW was not a company that we should have in our funds.”

Investors who shun such stocks will avoid big drawdowns in their portfolios. Data from fund analytics firm, Cerulli Associates, indicates that 18% of the US$36.8 trillion ($50.2 trillion) of funds in the US by end-2014 was managed on ESG principles. The asset value of these funds also grew at the fastest annualised rate of 76% among fund groupings from 2012 to 2014.