Going Green, SRI, ESG – Whatever You Call It, Investors Now Demand Sustainability
By Peter A. Soyka, President of Soyka & Co., Author, “Creating a Sustainable Organization: Approaches for Enhancing Corporate Value Through Sustainability”
Although investor relations and other senior corporate officials are generally unaccustomed to receiving questions about their firm’s sustainability position and performance, they can expect this to change. Investors and the analysts that serve them are increasingly turning their attention to an array of issues that extend beyond the conventional focus on the financials and perceived key business drivers. In fact, during the past five years or so, a growing movement spawned by the Socially Responsible Investing (SRI) community has taken shape that focuses squarely on a number of key environmental, social, and governance (ESG) issues. There are several reasons for this:
1. Asset owners demand it.
Increasingly, the trustees of major pension funds and other major institutional investors expect that the companies in which their funds are deployed will conduct their operations in a safe, legally compliant, and ethical manner, will implement effective and transparent governance practices, will treat their employees and others fairly and humanely, and will take adequate steps to ensure that they do not adversely affect the environment. Moreover, as younger investors, particularly those with substantial accumulated or inherited wealth, enter the investing market, they are beginning to deploy their capital in accordance with their values.
The simple truth is that younger people are generally more aware of and more concerned with sustainable business behavior than their elders, simply because they were raised in an era when pollution control and waste reduction were the norm. (Those of us who are a bit older can remember when this was not the case.) Such people are impatient with unethical, much less illegal, corporate behavior, and are beginning to vote with both their feet and their investment portfolios. This phenomenon, while interesting on its own, becomes a boardroom-level issue when one considers that funds invested according to at least some ESG criteria now account for about $3 trillion, or about 12 percent of U.S. equity markets. This level of control and market power simply cannot be ignored by either investment portfolio managers or responsible corporate senior executives.
2. Company customers require (or strongly suggest) it.
Although it is fair to say that U.S. consumers are not flocking to “green” products en masse, it can safely be said that more sustainable products are finding steadily greater market acceptance. Importantly, several major retailers, consumer product manufacturers, and industry groups have committed to more environmentally benign or sustainable practices, including the avoidance of certain substances or methods, reductions in material and energy use, more ethical labor practices, and a variety of other measures.
Companies in businesses that are consumer-facing and/or in the supply chains of companies such as WalMart and Procter & Gamble already are addressing expectations that they evaluate the life cycle impacts of their products, as are firms that sell to the U.S. federal government, the nation’s largest purchaser of goods and services. These developments are beginning to have profound ripple effects on many companies and industries, and we can expect that they will intensify during the next several years, as expectations from consumers and major intermediaries proliferate. Obviously, the stakes here are large, as any significant change in consumer behavior or supply chain relationships can have major impacts on a firm’s revenues and profitability.
3. Because they can outperform.
With the emergence in recent years of more sophisticated approaches to ESG investing (as opposed to traditional, values-based SRI screening), it has been shown that the skillful practitioner applying such approaches can perform as well and often better than his/her counterparts using conventional investment techniques. In particular, ESG investors using positive screening and best-in-class approaches to select stocks often outperform their benchmarks, as well as most other actively managed alternatives. Moreover, extensive published literature, which is profiled in depth in my recent book, documents the fact that more sustainably managed companies have…
- Higher returns on assets and equity
- Greater intangible asset value
- Fewer and smaller liabilities
- Less volatility (risk) and lower capital costs.
In fact, there is recent, published, quantitative evidence showing that financial market participants are now reacting to environmental and other sustainability issues, and how individual companies are (or are not) addressing them. For example, climate change risk is leading to higher interest rates and costs for firms that are perceived to be more vulnerable and/or have not provided evidence that they are adequately prepared to operate in a world with new carbon emissions constraints. Similarly, equity investors are pricing stocks as though GHG emission intensities will impose additional future costs, thereby limiting earnings and future return potential.
In short, investors increasingly are demanding sustainable business behavior and improved environmental, social, and governance performance over time because it reduces their investment risk (and thereby reduces their required rate of return), provides companies in which they are invested with growing and less volatile revenues, earnings, and cash flow, and provides opportunities for superior investment performance over time. In other words, it is not just the right thing to do, it is the smart thing to do.
Peter A. Soyka is the founder and President of Soyka & Company, LLC, an environmental and sustainability management consulting firm. He is the author of the recently published, critically acclaimed book, “Creating a Sustainable Organization: Approaches for Enhancing Corporate Value Through Sustainability.” He may be contacted at email@example.com.