Why investors need to look at a company’s environmental, social and governance structures

According to McKnett, investors aren’t paying enough attention to sustainability – things like environmental and social issues, as well as corporate governance. 

“I think it’s reckless to ignore these things, because doing so can jeopardise future long-term returns,” McKnett said. “And here’s something that may surprise you: the balance of power to really influence sustainability rests with institutional and large investors. I believe that sustainable investing is less complicated than you think, better-performing than you believe, and more important than we can imagine.”

He claimed that we have a population that’s both growing and ageing; we’ll have 10bn souls at the end of the century; we consume natural resources faster than they can be replenished; and the emissions that are mainly responsible for climate change keep increasing. 

“Now clearly, these are environmental and social issues, but that’s not all,” he said. “They’re economic issues, and that makes them relevant to risk and return. And they are really complex and the temptation may be to bury our heads in the sand and not think about it. But it makes me wonder if the investment rules of today are fit for purpose tomorrow. 

“We know that investors, when they look at a company and decide whether to invest, look at financial metrics like sales growth, cash flow, market share and valuation. But fundamental they may be, they’re not enough. Investors should also look at performance metrics in what we call ESG: environment, social and governance. Environment includes energy consumption, water availability, waste and pollution. Social includes human capital, such as employee engagement and innovation capacity, as well as supply chain management and labour rights. And governance relates to the oversight of companies by boards and investors.” 

ESG is the measure of sustainability, and sustainable investing incorporates ESG factors with financial factors into the investment process. It means limiting future risk by minimising harm to people and the planet, and it means providing capital to users who deploy it towards productive and sustainable outcomes.

“So if sustainability matters financially today, and all signs indicate more tomorrow, is the private sector paying attention? McKnett asked. “Well, the really cool thing is that most CEOs are. They started to see sustainability not just as important but crucial to business success. About 80 per cent of global CEOs see sustainability as the root to growth in innovation and leading to competitive advantage in their industries. Some 93 per cent see ESG as the future, or as important to the future of their business.”

One example of how companies are leveraging ESG to drive results is Pentair. Pentair is a US industrial conglomerate, and about a decade ago the boss sold its core power tools business and reinvested those proceeds in a water business. That’s a really big bet. However, the company thought there was more growth in water than in power tools, and this company has its sights set on what it calls “the new New World.” That’s 4bn middle class people demanding food, energy and water.

“Now, you may be asking yourself, are these just isolated cases?” he said. “I mean, come on, really? Do companies that take sustainability into account really do well financially? The answer that may surprise you is yes. So if the returns are the same or better and the planet benefits, wouldn’t this be the norm? Are investors, particularly institutional investors, engaged? Well, some are, and a few are really at the vanguard.

“Now, I do speak to a lot of investors as part of my job, and not all of them see it this way. Often I hear, ‘We are required to maximise returns, so we don’t do that here,’ or, ‘We don’t want to use the portfolio to make policy statements.’ The one that just really gets under my skin is, ‘If you want to do something about that, just make money and give the profits to charities.’ But let me clarify something right here. Companies and investors are not singularly responsible for the fate of the planet. 

“They don’t have indefinite social obligations, and prudent investing and finance theory aren’t subordinate to sustainability. They’re compatible. So I’m not talking about tradeoffs here. But institutional investors are the x-factor in sustainability. Why do they hold the key? The answer, quite simply, is, they have the money. A lot of it. IThe global stock market is worth $55tn. The global bond market, $78tn. That’s $133tn combined. That’s eight and a half times the GDP of the US. That’s the world’s largest economy. That’s some serious freaking firepower.”

But what if we work and save and invest, only to find that the world we retire into is more stressed and less secure than it is now? What if there isn’t enough clean air and fresh water? Former president John Kennedy said: “There are risks and costs to a program of action, but they are far less than the long-range risks and costs of comfortable inaction.” 

And as Mark Twain said: “Plan for the future, because that’s where you’re going to spend the rest of your life.”

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