Principles for Responsible Investment
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PRI: Companies with strong ESG credentials make better investments
Companies with better environmental, social and governance standards are more profitable and trade at a premium to rivals, according to research that shows responsible practices have a direct link to the financial performance of big businesses.
An analysis of more than 300 of the world’s largest pharmaceutical, consumer goods, oil and gas, banking and tech companies by the Boston Consulting Group found that those with more ethical operations, for example those seeking to conserve water, make bigger profits and are valued more highly than competitors.
For oil and gas companies, the valuation premium was almost a fifth for those that combat corruption, have better health and safety processes or attempt to limit environmental damage. Earnings before interest, tax, depreciation and amortisation were 3.4 percentage points higher for these groups, while in the pharmaceutical industry the ebitda margin benefit was more than 8 percentage points.
Wendy Woods, one of report’s authors, said improved transparency had made it easier to measure the financial impact of ESG issues. “You are seeing that investors and regulators are requiring more data and there are a number of initiatives out there, so companies are getting better at disclosing information,” she said.
According to Ronald O’Hanley, chief executive of State Street Global Advisors, such measurements will make it easier to invest responsibly. “Efforts to quantify the financial implications of ESG factors help investment managers incorporate them into investment models, both as signals for identifying outperformance potential and as red flags for potential risks.”
Investors are increasingly weighing up data about sustainable and ethical business practices before buying shares in listed companies, in an attempt to limit long-term financial risks from ESG problems. Socially responsible assets under management grew to $23tn last year — more than a quarter of the world’s total and up 27 per cent on 2014, according to the Global Sustainable Investment Alliance.
Earlier this year the UK’s pensions regulator warned that savers face long-term financial risks because trustees are failing to take climate change, responsible business practices and corporate governance into account when making investments.
However, many investors have expressed concern that responsible investment could limit performance. Almost half fear they will lose out on returns if they invest sustainably, according to a survey of 500 pension funds, foundations, endowments and sovereign wealth funds conducted earlier this month.
According to some investors, the benefits of ESG metrics could be eroded by a shift to passive investment. “Given the spread of the focus on environmental, social and governance in general in the investment community, if you are well run, then you will have more interest from the investor community,” said Louise Hedberg, head of corporate governance and sustainability at East Capital. “But, conversely, we have a lot of money invested in passive strategies that just fuel the benchmark.”
Better data could change this, according to Guido Giese, executive director of equity research at MSCI, the index provider: “What we can say now is that the impact [of ESG issues] on risk, volatility and valuation is clearly statistically significant.”
The argument is that responsible funds are less likely to experience unforeseen losses and more likely to outperform their benchmarks. “If we look at the news over the past few weeks, we see prime examples of what happens to established names such as Bell Pottinger, KPMG and Miramax when ESG issues are ignored,” said Fiona Reynolds, managing director of the UN’s responsible investment initiative, the UNPRI. “The damage can be irreparable.”