Winston Churchill expressed it best when he said, “The price of greatness is responsibility.
Responsible Investing is a balancing act. Investors have to balance positive ambitions for a better world with the practical implications of implementing their long term investment strategy in search of superior returns. There is no question that everybody wants to make the world a better place, but in the same world investors still require real and competitive returns in order to meet their liabilities and performance objectives.
GraySwan has been a PRI signatory since 2013 (the second investment advisor in South Africa to become a signatory) and have been awarded as the Responsible Investment Consultant of the Year at the most recent Baseta awards. We firmly believe that there is monetary value in Responsible Investment if you follow a step by step approach to incorporate such thinking into your investment process.
CAN IT BE DONE?
We’ve already done so successfully for our institutional clients and their top performing track records are proof that responsible and sustainable investing is part of a winning strategy. Our next journey is to do so for our private clients as the only difference is that they have to invest in off the shelf products whereas for our institutional clients we can tailormake such solutions. It’s great to add value in terms of performance and doing good at the same time.
Initially we had to make use of theoretical studies and surveys to judge whether companies and investment managers that incorporate Environmental, Social and Governance (ESG) factors into their thinking outperformed their peers. One such study was the Global 500 Climate Change Report prepared by the Carbon Disclosure Project (CDP) which concluded that “companies that achieve leadership positions in climate change generate superior stock performance”.
Over the last few years, a few high profile examples have come to the fore which ensured that most investors take notice of the impact of ESG factors on sales and share price. One such company has been Volkswagen. In September 2015 the United States Environmental Protection Agency (EPA) found that Volkswagen had installed software in the diesel engines to activate certain emissions controls during laboratory testing. The software caused the nitrogen oxide (NOX) levels to meet regulatory standards but outside of the laboratory these same engines emitted up to 40 times more NOX than permitted. Volkswagen installed this software in 11 million cars over the period of 2009 to 2015.
Was there any reaction from customers, investors and shareholders? The share price dropped 23% within 1 day of the breaking of the news which wiped out EUR15.6 billion in market value. The share price continued to fall and ended the month 50% down.
BLACK SWAN VS GRAYSWAN?
These events are Black Swan events and could not have been predicted… or could it? MSCI ESG Research maintains ESG ratings on all listed companies and rate companies on Environmental, Social and Governance (ESG) factors against their peers. Interestingly, at the time, Volkswagen had very low ratings on especially Governance. The MSCI ESG World Index excluded Volkswagen and investors, like our institutional clients which were tracking this index avoided this share’s large capital loss.
However, not all Sustainable and Responsible Indices (referred to as SRI indices) outperform general market indices. One of the reasons being that many of these SRI indices only incorporate disclosure and transparency factors of companies when creating the indices. Albeit that this is already a step in the right direction, many of these indices fail to incorporate the actions taken by companies to improve their current situation. It is good to be transparent, but it’s better to do something about it.
Think about it… a company that reduces its carbon emissions should outperform its less carbon efficient peers. In order to reduce carbon emissions the company will have to reduce its wastage on fuel consumption, energy usage, water and waste management which in turn means more efficient use of inputs and therefore reduced costs.
THE PROOF IS THERE
The UN Global Compact-Accenture CEO Study on Sustainability previously surveyed 1,000 global CEOs, from 27 industries across 103 countries. Some of the key findings from the report were that 76% of CEOs surveyed believe that embedding sustainability into core business will drive revenue growth and new opportunities and that 93% of CEOs regard sustainability as important to success.
In a meta-study conducted by Arabesque Asset Management – “From the stockholder to the stakeholder” they found a remarkable correlation between diligent sustainability business practices and economic performance. The first part of the report explored this thesis from a strategic management perspective, with remarkable results: 88% of reviewed sources found that companies with robust sustainability practices demonstrated better operational performance, which ultimately translated into cashflows. The second part of the report showed that 80% of the reviewed studies demonstrated that prudent sustainability practices had a positive influence on investment performance.
In another report by Deutsche Bank Climate Advisors, they surveyed over 100 academic studies of sustainable investing from around the world. They found that Environmental, Social and Governance (ESG) factors were correlated with superior risk adjusted returns and showed that companies with high ratings of these factors had a lower cost of capital and their share prices exhibited outperformance.
The integration of Environmental, Social and Governance (ESG) factors into investment decision making has been gathering momentum over the last decade and such has now entered the mainstream. As an example, more than 75% of S&P500 companies are reporting on sustainability, demonstrating a growing recognition of the strong interest expressed by investors.
Sustainability and financial performance are linked.
We believe that by incorporating ESG factors into the analysis of companies and investment managers,
can results not only be seen in the outperformance of the market, but by also providing superior risk adjusted performance.
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