The busi­ness case for sus­tain­abil­ity

Financial Mirror (Cyprus) - - FRONT PAGE -

In­vestors world­wide are in­creas­ingly seek­ing in­vest­ment op­por­tu­ni­ties that prom­ise to bring en­vi­ron­men­tal and so­cial benefits, in ad­di­tion to mar­ket rates of re­turn. If this trend con­tin­ues, with the ad­vance­ment of en­vi­ron­men­tal or so­cial ob­jec­tives en­hanc­ing an in­vest­ment’s value, it will strengthen the com­mit­ment to sus­tain­abil­ity that is al­ready gain­ing mo­men­tum among busi­nesses around the world.

Last year, one out of ev­ery six dol­lars of as­sets un­der pro­fes­sional man­age­ment in the United States – a to­tal of $6.6 trln – was al­lo­cated to­ward some form of sus­tain­able in­vest­ment, es­pe­cially public eq­ui­ties.

Some 1,260 com­pa­nies, man­ag­ing $45 trln worth of as­sets, are sig­na­to­ries of the United Na­tions’ “prin­ci­ples for re­spon­si­ble in­vest­ment,” which recog­nise en­vi­ron­men­tal, so­cial, and gov­er­nance (ESG) fac­tors – and thus the longterm health and sta­bil­ity of com­pa­nies and mar­kets – as crit­i­cal to in­vestors. One sig­na­tory, CalPERS, one of the world’s largest in­sti­tu­tional in­vestors, has gone a step fur­ther: it will re­quire all of its in­vest­ment man­agers to iden­tify and in­te­grate ESG fac­tors into their de­ci­sions – a bold move that could trans­form cap­i­tal mar­kets.

The num­ber of com­pa­nies is­su­ing sus­tain­abil­ity re­ports has grown from fewer than 30 in the early 1990s to more than 7,000 in 2014. And, in a re­cent Mor­gan Stan­ley sur­vey, 71% of re­spon­dents stated that they are in­ter­ested in sus­tain­able in­vest­ing.

To be sure, a ma­jor bar­rier to in­cor­po­rat­ing ESG cri­te­ria into in­vest­ment de­ci­sions re­mains: many in­vestors – in­clud­ing 54% of the re­spon­dents in the Mor­gan Stan­ley sur­vey – be­lieve that do­ing so could lower the fi­nan­cial rate of re­turn. But there is mount­ing ev­i­dence that this is not the case, with sev­eral re­cent stud­ies in­di­cat­ing that sus­tain­able in­vest­ments do as well as – or even out­per­form – tra­di­tional in­vest­ments.

A sem­i­nal 2012 study that an­a­lysed two groups of com­pa­nies – sim­i­lar in terms of in­dus­try, size, fi­nan­cial per­for­mance, and growth prospects – found that those in the “high sus­tain­abil­ity group” had su­pe­rior share-price per­for­mance. And a new study by Mor­gan Stan­ley’s In­sti­tute for Sus­tain­able In­vest­ing, which an­a­lysed the per­for­mance of 10,228 open-ended mu­tual funds and 2,874 separately man­aged ac­counts in the US, found that sus­tain­able in­vest­ments usu­ally met – and of­ten ex­ceeded – the me­dian re­turns of com­pa­ra­ble tra­di­tional in­vest­ments for the pe­ri­ods ex­am­ined.

Many ESG fac­tors come into play when eval­u­at­ing sus­tain­able in­vest­ment op­tions. For ex­am­ple, the Gen­er­a­tion Foun­da­tion – the think tank of Gen­er­a­tion In­vest­ment Man­age­ment (on whose ad­vi­sory board I serve) – iden­ti­fies 17 en­vi­ron­men­tal fac­tors, 16 so­cial fac­tors, and 12 gov­er­nance fac­tors rel­e­vant to sus­tain­abil­ity.

The chal­lenge is to dis­tin­guish be­tween the ESG fac­tors that have a ma­te­rial in­flu­ence on com­pany per­for­mance and those that do not. But the data that com­pa­nies cur­rently re­port are in­ad­e­quate to en­able in­vestors to make this distinc­tion.

The non-profit Sus­tain­abil­ity Ac­count­ing Stan­dards Board (SASB) is at­tempt­ing to change that by de­vel­op­ing ma­te­rial sus­tain­abil­ity ac­count­ing stan­dards for 80 in­dus­tries, con­sis­tent with the US Se­cu­rity and Ex­change Com­mis­sion’s com­pli­ance reg­u­la­tions. More than 2,800 par­tic­i­pants – in­clud­ing com­pa­nies with mar­ket cap­i­tal­i­sa­tion to­tal­ing $11 trln and in­vestors with $23.4 trln in as­sets un­der man­age­ment – have been in­volved in the SASB process. Us­ing the SASB’s pro­posed stan­dards for 45 in­dus­tries, as well as other met­rics, a new study – the most de­fin­i­tive so far – has found that com­pa­nies that per­form well on ma­te­rial sus­tain­abil­ity fac­tors have bet­ter op­er­a­tional per­for­mance, are less risky, and earn sig­nif­i­cantly higher share­holder re­turns than com­pa­nies that per­form poorly.

Sim­i­larly, a new frame­work re­cently pro­posed by Mor­gan Stan­ley for val­u­a­tions of com­pa­nies in 29 in­dus­tries in­cludes ESG fac­tors that pose ma­te­rial risks or op­por­tu­ni­ties. Whereas a com­pany is tra­di­tion­ally val­ued based ex­clu­sively on how it de­ploys fi­nan­cial cap­i­tal to gen­er­ate re­turns, the new frame­work in­cor­po­rates how it de­ploys nat­u­ral, hu­man, and so­cial cap­i­tal, as well as the trans­parency of its gov­er­nance prac­tices. This new ap­proach to com­pany val­u­a­tion re­flects the view that the most suc­cess­ful com­pa­nies will be those that deploy all four kinds of cap­i­tal re­spon­si­bly.

Con­sider in­vest­ments that im­prove the en­ergy ef­fi­ciency of data cen­ters, which use 10-20 times more en­ergy than av­er­age com­mer­cial build­ings, and thus are re­spon­si­ble for con­sid­er­able green­house-gas emis­sions. De­ci­sions about data-cen­ter spec­i­fi­ca­tions are im­por­tant for man­ag­ing costs, ob­tain­ing a re­li­able sup­ply of en­ergy and wa­ter, and low­er­ing rep­u­ta­tional risks, par­tic­u­larly given the in­creas­ing global reg­u­la­tory fo­cus on cli­mate change. Google’s con­struc­tion of data cen­tres that use 50% of the en­ergy of an av­er­age data cen­tre has brought it con­sid­er­able sav­ings.

Sim­i­lar suc­cess sto­ries have played out across sec­tors. Since 2011, the US chem­i­cal com­pany DuPont has in­vested $879 mln in re­search and devel­op­ment of prod­ucts with quan­tifi­able en­vi­ron­men­tal benefits; it has recorded $2 bln in an­nual rev­enue from prod­ucts that re­duce green­house-gas emis­sions, and an ad­di­tional $11.8 bln in rev­enue from re­new­able re­sources like wind and so­lar power.

Like­wise, the multi­na­tional con­sumer goods com­pany Proc­ter and Gam­ble re­ported $52 bln in sales of “sus­tain­able in­no­va­tion prod­ucts” from 2007 to 2012. That is roughly 11% of the com­pany’s to­tal sales over that pe­riod.

There are good rea­sons to be­lieve that, by in­vest­ing in im­prov­ing ma­te­rial sus­tain­abil­ity, com­pa­nies can in­crease share­holder value. In fact, if a com­pany is to ful­fill its fidu­ciary re­spon­si­bil­ity to its in­vestors, it has lit­tle choice but to go be­yond fi­nan­cial re­turns to in­cor­po­rate ESG fac­tors that are likely to have a ma­te­rial im­pact on its per­for­mance over time. This is pre­cisely the kind of in­cen­tive that could pro­pel the world to­ward a more sus­tain­able fu­ture.

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