Operating to an ethical mantra can boost the bottom line
SUSTAINABILITY is no longer considered an ethical or moral issue in investment decision- making, but has helped provide superior financial returns and acted as a flag for investors to avoid high- risk companies, financial market analysts say.
Environmental, social and governance issues ( ESG) are now becoming a key factor in capital market investment decisions, and increasingly money managers are seeking out companies with a high ESG rating — those that have a sound environmental track record, that take care of their staff, relate well to the community around them, and have a well- run ship with good leaders at the helm.
Over the medium to long term, sustainability will be a key driver of investment returns and risk,’’ saya Andrew Gray, head of ESG research at Goldman Sachs JBWere.
ESG is not just a moral issue, it’s about the effect on returns. We have found clear links to value in ESG which means it is completely relevant to investors,’’ Gray says.
Shane Oliver, chief economist at AMP Capital Investors, says there is a growing interest in sustainable investing and that while it was considered a fringe’ style of investment a decade ago, it is now becoming more prominent. The perception years ago was that it was something for greenies, but there is clear evidence that it enhances returns on sharemarkets and it is starting to become more mainstream,’’ he says.
In a report released last month, Oliver’s colleague, senior analyst Alan Woods, says that environmental and social issues are likely to be among the most critical factors shaping government policy and corporate strategy within the next 10 years. ESG issues are now a necessary part of investment decisions, Woods says.
A sign that sustainability has become a focus for Australia’s institutional investment community is the strong corporate participation in the UN’s PRI initiative — the Principles for Responsible Investment. The PRI is a voluntary initiative where signatories commit to give appropriate consideration to ESG issues and incorporate them into mainstream investment decision- making.
Signatories ( to the initiative) are working through how to implement the principles and integrate them into their investment decisions, so it ( ESG) is being seen as something that provides investment value,’’ says Elaine Prior director and senior analyst at Citi Investment Research. However, Prior says while ESG issues are only now becoming a larger focus for some investors and analysts, she believes ESG has been practised for some time now.
She says that over time, ESG will simply be a normal part of what investors take into account when assessing companies — it shouldn’t be seen as a short- term, separate issue.
With the growing awareness of the importance of sustainability or ESG issues in investment circles, there has been little work to quantify what it may mean in dollar terms to Australia’s publicly- listed companies.
Goldman Sachs JB Were is leading this work in Australia and expects to establish the country’s first sustainability index’ of top performing Australian companies across all areas of ESG within the next six months. The index will be the first of its kind, rating companies across all areas of ESG and not just on single areas such as business sectors or on the environment.
In his work so far to establish a ratings system for the sustainability index, Gray says he has found some significant relationships to price performance of stocks which rated highly in the area of corporate governance.
Using seven years of data from partner CGI Solutions, Gray says companies that rate highly in the governance area are outperforming other ASX200 companies.
He says where companies rate well on remuneration they returned an average of 47 per cent more than the market. Where companies rate well on audit processes the return was 37 per cent above market and where they rate well on board skills they returned an average of 19 market.
Based on these results, we conclude that corporate governance analysis can help improve investment returns. Based on our research we think governance is highly valid.’’ He says in the area of human capital management, a part of the social aspect of ESG, workplace health and safety is useful as a risk screen to help screen out underperforming stocks.
According to his research in this area, based on data from Regnan, stocks with poor health and safety records underperformed the ASX200 by 30 per cent during the past four years since data was available.
Sound ratings for companies in the area of workplace health and safety can act as a good risk screen for underperforming stocks, it doesn’t pick outperformance but we believe it is a benchmark you should consider,’’ Gray says.
Gray says that with the imminent mandatory emissions trading legislation due to be in place in Australia by 2010, companies with heavy carbon emissions could face costs of up to one- third of annual profit.
His research shows that under a new carbon emissions trading scheme, BlueScope Steel could be faced with costs of around 34 per cent of its earnings before interest and tax, depreciation and amortisation ( EBITDA) — based on a carbon price assumption of $ 20 per tonne and assuming no compensation or dispensations from government.
Similarly, Onesteel would face losses of 16 per cent of profit, Alumina Ltd 14 per cent and Qantas 11 per cent of profit.
This is all potential risk,’’ says Gray. It can’t be fully costed until the details of the ( Rudd Government’s carbon trading) scheme are fully available and the draft legislation is expected in December.’’
Citi Investment Research on carbon emissions trading by Prior shows that the cost to emissions- intensive companies could be between 5 to 45 per cent of current market value in the absence of any abatement solutions, although some costs may be passed on to customers. Her work is also based on a $ 20- a- tonne carbon price.
According to Prior, 75 per cent of companies in the ASX100 will have exposure to the carbon issue and the companies most exposed will be in the steel, aluminium, petroleum, cement, chemicals and minerals processing industries. Energy generators also qualified, but should benefit from higher power price.
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Mainstream shift: Shane Oliver