Sustainable investing: high on investors’ agendas in an uncertain world
The world is currently facing a myriad of macroeconomic challenges. Globalisation and cross-border collaboration are under threat, seemingly replaced by insularity and self-interest. The recovery from the global financial crisis, driven by quantitative easing, has been uneven across societies while trust in the political establishment is at an all-time low. Rapid technological developments mean an everincreasing range of jobs is under threat from robotics and artificial intelligence. And despite 2016 being the warmest year on record, climate change denial is back on the political agenda. It is unsurprising that against this backdrop, investors’ interest in sustainable investing has surged, as they seek ways to counter the retrograde consequences of populism.
People, planet and profits
Although sustainable investing is not new, its influence is accelerating as it attracts a rapidly growing pool of assets. Increased regulation has played its part but, encouragingly, companies, employees, consumers and investors are also beginning to see the fundamental benefits of creating a more sustainable future for society and the planet.
The UN’s Brundtland Commission in 1987 defined the concept of sustainable development, and in 1989 Swedish academic Karl-Henrik Robèrt introduced the highly regarded ‘Natural Step Framework’, which set out conditions for the sustainable development of human activity on the planet. The most famous concept to emerge from the early work in this space was John Elkington’s 1994 ‘triple bottom line’ – people, planet and profits.
Dr Robèrt’s work scientifically demonstrated that we live in a complex, adaptive ecosystem with a high level of interdependence between its various components. This is why investors and companies need to take a holistic approach to managing their activities. Maximising the utility of one part of the system, such as short-term profits, may well have significant impact elsewhere that ultimately renders those profits unsustainable over time.
Why take a holistic approach?
A recent medical study clearly illustrated why a holistic perspective on the interaction between businesses and the public is essential. The study pointed to a causal link between living in proximity to heavy traffic routes and an increased risk of developing Alzheimer’s disease. This reinforces the notion that you do not need to believe in climate change to recognise that an indifferent attitude to pollution could be damaging the quality of life for millions now, and building immense future healthcare costs for society. Beijing and Shanghai often hit the headlines for their appalling levels of pollution, but the air in London and Paris has also reached near toxic levels on some days. This puts the shareholder opprobrium and regulatory fines heaped on Volkswagen in the US following its decision to cheat emissions tests into appropriate context. Actions like these not only negatively impact people and the planet but ultimately damage shareholder returns.
Historically, sustainable investment has been left to specialist sections of the market focusing on socially responsible investing (SRI), environmental, social and governance (ESG) or social enterprise approaches, where social and environmental considerations were often placed ahead of financial returns. Increasingly, however, the focus is on integrating these considerations into all investment approaches as investors recognise that this can add long-term value to portfolios. In effect, investors are now applying the principle of ‘do no harm’ to investing.
Poor corporate governance destroys returns
When clients ask for proof that ESG investing works, we instead ask why one would not consider the ESG behaviours of a company when assessing a new opportunity? It makes long-term economic sense to invest in companies that limit their consumption of scarce, finite resources, eliminate harmful waste that is costly to recycle, and have high standards of environmental efficiency that allay the need for regulatory fines. Managing environmental considerations like these not only boosts financial returns, but makes a business more sustainable over time.
On the social side, companies with poor labour practices have higher staff turnover, more frequent strikes and increased instances of illness and injury – which all contribute to lower productivity and damage corporate reputations.
As research by our Global Equities team has demonstrated1, companies with the poorest standards of corporate governance systematically diminish shareholder returns and typically suffer lower valuations, raising the cost of capital. We integrate ESG considerations into our thinking because it makes financial sense and improves the sustainability of those returns over time.
Companies have a complex set of effects – positive and negative – on the environment and society. Measuring these is often a hard task and can lead to an excessive focus on the here and now. This can mean that not enough consideration is paid to the direction of travel of a business and can fail to recognise those companies that are improving. As responsible investing goes mainstream, the data available to measure companies’ ESG impact will increase dramatically. While this will improve the scrutiny and awareness of the sustainability of businesses on the margins, we believe a truly holistic approach to investing must go much further.
Integral to system-wide sustainability is the role of investors in encouraging credible and lasting change in companies. As agents of change, investors will need to rethink many aspects of their investment processes, from the way they engage with companies through to the time horizon of their investments. Public market equities provide a significant opportunity for driving future prosperity for all, given the breadth and scale of their effect on society. Shared prosperity would enhance society’s ability to create a sustainable system for allocating increasingly scarce resources.
While having a different emphasis, the UN’s Sustainable Development Goals for 2030 are a useful guide to sustainability for companies and investors alike. Although these goals do not explicitly translate into business, they can help identify negative outcomes from human activity, particularly poverty, which companies can contribute to resolving through positive working practices. It is not sufficient to look solely at ‘best in class’ businesses because, to achieve a sustainable economic model in a world of scarce resources, we need to eradicate poor behaviours and compound the positives.
Sustainability in the value chain
Investors seeking strong holistic returns should consider whether sustainability is embedded into a company’s value chain. Planting trees to compensate for pollution emitted elsewhere is nowhere near as valuable as reducing the primary level of pollution. Even an environmentally friendly business, such as a wind turbine manufacturer, should not rest on its green laurels. It must ask whether its manufacturing process is environmentally friendly and lowering the consumption of raw materials? Is it considering products’ life cycles and facilitating the refurbishing or recycling of its products?
Central to the ability to encourage and influence change is active and collaborative engagement between investors (acting as the agents of asset owners) and companies. But collaboration is not only about asset owners joining forces to convey a louder and more consistent message to company boards. It is also about working with management to understand and support long-term business objectives that will lead to a more sustainable system. Engagement provides the additional benefit of an effective feedback loop that better informs the investment manager, supporting a long-term approach.
Thinking actively about a company’s sustainability characteristics at the start of the research process is essential to increasing the sustainability of returns. Investors who consider these characteristics can engage from the offset with management on areas of concern where improvements could lead to higher and more sustainable future returns. By establishing a culture of active engagement at the outset of an investment, an investor reduces the necessity of reactive and more strident action later.
The investment management industry is accused of being short term in its assessment of business success and in its management of client assets. While some investors see companies as little more than tickers and factors to be traded at ever higher frequency, a greater awareness is emerging of the investment industry’s influence on the economy and society. A more holistic approach to investing should consider the long-term nature of value creation, and how it can deliver improved prosperity without degrading the environment. Prosperity as a concept goes beyond measuring the profitability of individual businesses or the notion of personal wealth. Instead, truly holistic investment should focus on how purposeful economic activity can contribute to the development of a more sustainable system overall.