More and more, investors are asking for sustainability in their investments. Research shows younger people are even more passionate about this.

Many people want to know their money is being used for good. In this modern world of ethics and transparency, companies best set for success are those committed to being leaders by making their business practices more sustainable.

These market leaders are doing existing things differently or doing different things.

The world of investment is changing every day. New government rules, environmental restrictions, and consumer choices are all driving this change.

This means many business activities that were profitable in the past will face new headwinds in the future.

One of these is the demand from consumers for Environmental, Social and Governance (ESG) practices. This covers a wide range of criteria, including sustainability and environmental impact, a company’s relationships with employees, customers, and communities, and even leadership.

Not just a feel-good issue

Increasingly, when I talk about good ESG performers, I’m not referring to ‘feel-good’ companies.

I mean high-quality companies operating in industries that are set for growth, who also have a strong grasp of ESG issues.

These are big forces that can hit a company hard and fast, and it’s increasingly evident that they’re making an impact.

Many forward-thinking and socially conscious investors are already considering ESG as they make decisions about their investments.

Link with top performers

There’s a good reason for this. Research is increasingly showing a positive link between ESG and corporations’ financial performance.

As people become aware of this, money is following, as capital increasingly flows into ESG strategies. And as more money goes into these companies, performance goes up – especially in the past 12-18 months.

Here’s an example of the pressures fuelling this change. The California Energy Commission decided in May this year that solar panels must be fitted to the roofs of most new homes, condominiums, and apartments in the state, from 2020. This is an obvious boost for the solar energy industry.

Another component of ESG performance is minimising carbon emissions.

Over the past five years, there has been a big corporate focus on carbon emissions, as companies position themselves for a future where carbon emissions have a cost, are limited, or both.

Many of the world’s top listed companies are committed to dramatically reducing their carbon emissions. Microsoft, for example, has been carbon neutral since 2012, and has generated returns to its shareholders of
200 per cent over this time.

Take a look at the MSCI Low Carbon Leaders Index. This index has outperformed the MSCI All Country World Index every year over the past five years to 31 March 2018.

There are three trends driving these returns:

Choice: There’s an increasing movement towards investments that consider their impact on the environment. Specifically, research shows that how well a company manages ESG risks has a direct impact on how well it performs. As investors, we simply can’t ignore these facts.

Follow the money: Second, investors are switching a rapidly growing lump sum of investment capital into ESG. There’s been a dramatic growth in socially responsible investment assets (SRI), which includes ESG. Investors choosing to ignore this will simply be left behind.

Performance: A compelling argument is that as people become aware of good ESG management and more money is allocated to these companies, their returns have been increasing. Socially responsible stocks used to have trouble beating the S&P500 (the list of the largest US publicly traded companies by market value) – until 2017. Since then, they’ve surged ahead.

Moving to the future

More and more you hear about company valuations being linked to brand and reputation, rather than property and equipment.

At a board level, the New Zealand Stock Exchange, the Financial Markets Authority, the Institute of Directors and the NZ Productivity Commission are all increasingly focused on firms managing and disclosing ESG risk.

And there’s been ongoing blurring of what is ESG and what is ‘normal’ risk – most recently, in the financial consequences of the data privacy controversy. Privacy is a social issue, but public concern about it had a swift and terrible impact on Facebook’s share price.

If you haven’t considered ESG as you plan your investments, it’s probably time you did.

There’s increasing evidence for the link between good management of ESG risk and corporate financial performance. This isn’t feel-good – it’s simply fact.

Definitions

MSCI ACWI Low Carbon Leaders Index: Aims to achieve 50 per cent reduction in the carbon footprint of the MSCI parent index, by excluding companies with high carbon emissions.

Standard & Poor’s 500 Index (S&P500): A market capitalisation weighted index of the 500 largest US publicly traded companies, across all industries, by market value.

First published 26 November 2018

Story by Paul Gregory, Pie Funds

This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser. This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.