Most corporate leaders understand that businesses have a key role to play in tackling urgent challenges such as climate change. But many of them also believe that pursuing a sustainability agenda runs counter to the wishes of their shareholders. Sure, some leaders in large investment firms say they care about sustainability, but in practice, investors, managers, and analysts rarely engage corporate executives on environmental, social and governance (ESG) issues. The impression among business leaders is that ESG just hasn’t gone mainstream in the investment community.
That perception is outdated. nowadays, ESG is becoming a universal practice in many organizations. Indeed, investors have been voicing concerns about sustainability for several decades but they have not put their words into practice Corporate leaders will soon be held accountable by shareholders for ESG performance- if they haven’t already.
Investors now look for companies that address ESG issues. They seek to analyze material issues such as climate risk, board quality or cybersecurity in terms of how they impact financial value positively or negatively. That is the integrative approach most companies and shareholders should seek for all types of investments.
Sustainable investing encompasses a menu of strategies that can be used in combination with several factors not limited to ESG integration. The first step business and corporate leaders can take to prepare for this shift in focus, is to recognize the forces driving it. Once they understand why investors care so much about ESG issues, they can make changes within their organizations to maximize long-term value for shareholders.
What is driving this change?
Over the past couple of years, several factors have acted as tailwinds for the heightened focus on ESG for investors. For one, large investment firms can maximize returns by combining investments from asset classes with varying levels of risk but not so much for system-level risks. Small investment firms might be able to hedge against climate change and other system-level risks by investing in ‘shares that build survival shelters, for example. But firms that have more dollars under management have no hedge against the global economy; in short, they have become too big to let the planet fail.
Many company managers still equate sustainable investing with its predecessor, socially responsible investing and believe that adhering to its principles entails sacrificing some financial return to make the world a better place. Sadly, that view is not true. The new generation of sustainable investing focuses on “material” ESG issues that impact a firm’s valuation –for example, green gas emissions are material for an electric utility company but not for a financial service provider, supply chain management that cuts on costs and the carbon footprint is essential for an apparel company but not a pharmaceutical company.
Sustainable investing is all about materiality. A company that spends sums of money trying to address every conceivable environmental, social and governance concern will likely see its financial performance suffer. However, those that focus on material issues tend to outperform those that do not.
Materiality varies by industry. For example, companies in the food industry, retail and distribution include green gas emissions, energy management, access and affordability, fair labour practices and fair marketing and advertising. For internet and media companies, they may take into account energy management, water and wastewater management, data security and customer privacy, diversity and inclusion and competitive behaviour.
Mainstream investors now look for evidence that a company’s portfolio is focused on the material ESG issues that matter to the financial performance, rather than on some ill-defined commitment to “sustainability.” It is time companies changed their old ways of doing business.