A new report by independent research firm Morningstar recently showed that European funds deemed to be 'sustainable' were more likely to be top performers. According to the Financial Times newspaper in a 12 August 2019 article: "Morningstar examined the net return of funds domiciled in Europe. More than 34% of sustainable funds appeared in the top quartile of their category in the year to June and about 63% made it into the top half."
Sustainable investments show a similar trend in South Africa, showing that companies with better environmental, social and governance (ESG) performance do better than corporate peers who pay less attention to these social, compliance and environmental levers.
As Morningstar noted with regards to European performance: "These numbers are consistent with evidence from academic research that suggests no systematic performance penalty associated with sustainable investing and possible avenues for outperformance based on reduced risk or added alpha."
In fact, noted a 2015 academic paper in the Journal of Sustainable Finance and Investment (ESG and Financial Performance: Aggregated evidence from more than 2000 empirical studies), about 90% of academic research "find a non-negative ESG-corporate financial performance relation. More importantly, the large majority of studies report positive findings."
This, believes Chantal Marx, RMB Private Bank's Head of Research, reinforces why the 'rational investor' is increasingly putting money into companies that are interested in sustainability and ESG. "Generally companies that rank highly from an ESG perspective tend to outperform those that don't," says Marx, and this links directly back to managing investment risk.
"Even if you consider governance and board structures, having a diverse board from a gender and race perspective reduces the probability of group think, which means boards are less likely to miss something or make massive mistakes," explains Marx. While, on the social side, community impact is critical, as are environmental concerns.
While there are degrees of concern which we associate more with some industries than others, what is becoming increasingly apparent around the world is that "when your social responsibility outlook isn't strong and your programmes aren't strong, it will have an impact on your bottom line", says Marx. This is driving companies to consider society at large when they make day-to-day business decisions, from poor working conditions to damaging environmental impacts.
Companies in morally ambiguous industries are particularly at risk of investor perceptions around the risk associated with their activities, making moves by the likes of miners, big tobacco and alcohol to align themselves with good ESG particularly noteworthy. After all, says Marx, "it is one thing for a financial services company to take its entire head office off the grid, but it's much more important that an oil company doesn't destroy an ecosystem due to an oil spillage".
Similarly, even if your investment is socially motivated and your intention is to benefit all stakeholders, it's still important to keep the bottom line in focus. And this rotates back to risk.
"Ultimately you will get to a point where your risk may be lower due to your focus on ESG," explains Marx. "If you are a mining company, for example, and you chose not to focus on the environmental aspects of your business, then you might face fines and social backlash. That would ultimately result in a loss of profit and lower returns. But if you are focused on the environment and diligently spend money every year to ensure what you are doing is best practice, then it would presumably cost you incrementally less and have a much less negative impact for shareholders."
Why does it matter?
Author and corporate governance specialist Nell Minow once observed: Boards of directors are like subatomic particles - they behave differently when they are observed.
"I love this quote," says Marx, explaining that it sums up the importance of ensuring that trusted bodies like boards continue to act in the best interests of shareholders. But even with these checks and balances, scandals do break. Consider the ongoing probe into the Resilient stable, the Facebook-Cambridge Analytica scandal, Steinhoff, Petrobras or concerns around Glencore's dealings in the Democratic Republic of Congo.
None of these inspire investor confidence, says Marx. And all hit the company in question's bottom line and share price, with the likes of the Steinhoff scandal all but wiping out shareholder equity.
For investors, already being pummelled by uncertain markets and geopolitical machinations, the damage done by not paying attention to the likes of ESG is a concern which can be avoided by applying a sustainable investing lens.
What is sustainable investing?
While sustainable investing as a concept is growing in popularity around the world, few fully grasp the concept beyond looking at companies with an ESG focus.
BlackRock, the global investment firm, puts it this way: "Sustainable investing is about investing in progress, and recognising that companies solving the world's biggest challenges can be best positioned to grow. It is about pioneering better ways of doing business, and creating the momentum to encourage more and more people to opt in to the future we're working to create."
Marx explains that there are a variety of components to sustainable investing, from responsible investing to impact investing, investing for change and even shared value. "ESG and, to a certain extent, religious investing also fall into sustainable investing, such as Shariahcompliant investing," she explains. "But the general point is not only thinking about the profits, the bottom line and maximising shareholder returns, but looking at it from a stakeholder perspective. And this extends from employees all the way through to people living in the communities where companies run their businesses. Its's about being very cognisant about what you are doing and how it is impacting society at large."
While shared value talks to finding business opportunities in addressing social issues, and impact investing to having a measuring social or environmental impact as well as a financial return, both of these and their associated investment philosophies have a social element merged with a financial imperative. Increasingly this is an appealing mix for investors with a social conscience as well as an eye to risk management. And that, the data is telling us, is a positive combination.