When did the ethical and sustainable investment strategy become a serious consideration for shareholders, investors and asset managers?
The global investment approach of shareholders, investors and investment managers is changing. We are currently seeing wealth transfer to millennials, environmental disasters, increased costs and risks, and better performance of operations through sustainable practices.
The importance of environmental, social and governance (ESG) factors in investment decision making, as noted by Boston Consulting Group in its recent article; Investors care more about sustainability than many executives believe, that 75% of senior executives at investment firms see ESG factors as materially important to their investment decision. The disconnect is evident that only 60% of companies have a sustainability strategy, and only 25% have developed a clear business case for sustainability.[1]
ESG incorporates a wide range of impacts on the risk and return values of an investment. These issues may be related to regulatory changes, business ethics, or direct impacts on financial, operational, strategic, or reputational risks. Examples of such risks are:
Environmental: natural resources, waste, climate change, pollution and clean technologies.
Social: health and safety, local community, human rights and human resources.
Governance: compliance, regulation, reporting, conflict of interest at employee, shareholder or board levels.
The transition from purely fundamental investment approaches, to consider the medium and long-term impacts of our business decisions on the environment, social and governance will affect the market from small to medium-sized companies, suppliers, manufacturers, supply chain, agribusiness, health care, large companies and listed companies to multinationals. It is investment and capital flows that drive our economy and the complex ecosystem of the global economy understands the value of a sustainable ESG strategy where they want to invest their funds.
The Australian market has generally struggled to accept how to assess corporate governance, social and environmental policy and often does not see it as profitable. Reporting on ESG in Australia until recently was not an important process for listed companies, and investment in ESG’s internal risk reduction strategy was minimal.
The range of environmental impacts on businesses and their operations can vary significantly and some organizations are better able to take advantage of them more than others. Quantifying environmental risk is a challenging process to put in terms of monetary value, yet the transition to a low-carbon economy is a key driving force. To achieve a low carbon economy requires investment to improve operational efficiency in the use of energy, waste and water through the use of clean technologies.
Social impacts and risks require an analysis of the immaterial characteristics of a company that are not in balance, such as culture, employee productivity, customer relations, health and safety, commitment to the community and sustainable supply chains. Social business decisions often surround ethics that work alongside profit. Although they do not typically have a direct impact on business performance, ethics and partnership are an important process of modern business practices.
External analysis of corporate governance processes can also present its challenges. Corporate behavior, decision-making, and policies require publicly traded companies to report extensively, usually wrapped in large volumes of data. A clear example of governance risk was the Volkswagen diesel emissions scandal in 2015. In EY’s report, Investing Rules of Tomorrow: How Global Institutional Investors are Using ESG to Inform Decision Making in 2015, (2015 ) mentioned that ‘almost two-thirds of respondents believe that companies do not adequately disclose ESG risks’.[2]
Harvard Sustainability Review, (2012), made a direct comparison between high sustainability organizations and low sustainability organizations of similar size, operations and sectors. “In particular, we track corporate performance for 18 years and find that High Sustainability companies outperform Low Sustainability companies in both the stock market and in accounting performance.”[3]
The opportunity to improve ESG performance is crucial for both listed and private companies. Investments in sustainable practices improve long-term bottom line performance, mitigate risk, and now represent a significant part of the business. Although investor-driven, companies must realize the importance of comprehensive ESG reporting, creating a sustainable strategy, and building an ethical business culture. The educated and ethical investor and consumer of the 21st century is here, and they see value in sustainability.
[1] Unruh, Kiron, Kruschwitz, Reeves, Rubel, Meyer Zum Felde, GU, DK, NK, MR, HR, AF, 2016 Investors care more about sustainability than many executives realize. 1st ed. Global: Boston Consulting Group.
[2] Bell, Gordon, MB, JG, 2015. Investing Rules of Tomorrow: How Global Institutional Investors are Using ESG to Inform Decision Making in 2015. 1st ed. Global: Ernst and Young.
[3] Eccles, Ioannou, Serafeim, REIIGS, 2012. The impact of corporate sustainability on organizational processes and performance. 1st ed. United States: Harvard Business School.
