Can a company increase its profits, reduce waste, improve its compliance standards and meet the aspirations of its stakeholders, while enjoying financial benefits such as lower capital limitations and a lower cost of debt? The answer is “yes”. Verity Hambrook explains how.
It is a common misconception that profit and business growth must come at the price of environmental degradation and a disregard for the needs of the world’s communities. Evidence is increasingly mounting that sustainability may be critical to long-term business success and future returns. What’s more, investors are starting to take notice. “Sustainable and responsible investment is thriving,” says Penny Shepherd, Chief Executive of the UK Sustainable Investment and Finance. “Across the investment management industry, far more investment houses are now implementing investment approaches,” she says.
An increasing number of companies are generating sustainable value and wealth with innovations that boost their reputation and, crucially, their share price. For example, a meta-study conducted by Innovest Strategic Value Advisors and the UK Environment Agency indicated that out of the 60 studies analysed, 51 show a positive correlation between environmental governance and corporate financial performance.
The strength of future share-value depends on a sustainable approach. Resource shortages and environmental limitations, brought about by an old and unforgiving form of capitalism, will continue to destabilise our economy. It is an uncomfortable truth but one that introduces a demand for innovation in the way we do business and what we invest in.
Doing more with less
A recent report entitled More with Less: Scaling Sustainable Consumption and Resource Efficiency, published by the World Economic Forum, contained some telling figures. In the last four years, 450 million people have been lifted out of poverty, and the number of households in the emerging and developed world living on an income of more than £1955 per annum increased by 28%, the report says.
But at what cost? In the same four years, the world has lost 21 million hectares of forest, generated 9.1 billion tonnes of solid waste and consumed 50 billion tonnes of fossil fuels. The report campaigns for an urgent change of pace in expediting the world’s sustainable progress. Investors and businesses have a powerful role to play in accelerating progress in this direction.
Recently, Al Gore, former US Vice-President, published a new white paper designed to encourage sustainable investment and share his vision of how “sustainable capitalism” will benefit companies and investors. Writing in the five point plan, Gore warns that many investors’ assets could see their value plummet if environmental factors, such as the price of carbon, are taken into account.
The Manifesto for Sustainable Capitalism notes that companies that have integrated sustainability into their business practices have increased profits, reduced waste, achieved improved compliance standards and met the aspirations of their stakeholders, while also enjoying financial benefits such as lower capital limitations and a lower cost of debt. Investors savvy enough to identify such companies can expect substantial returns and less volatility, the manifesto maintains.
It is an unambiguous message. And Al Gore is not alone. A group of UK investors, including representatives from Aviva, have been lobbying the Bank of England and the European Central Bank (ECB) to investigate the systemic risks posed by exposure to high-carbon assets. “The depth and breadth or our collective financial exposure to high-carbon, extractive and environmentally unsustainable investments could become a major problem as we transition to a low-carbon economy,” the group warns in a letter to the ECB.
“For investors it’s quite simple. To create long-term value and guarantee returns, any investment should be selected on its future outlook, its risk exposure and the opportunities it presents,” says David Beer, director of IndustryRE Sustainability. “Sustainable investment lessens risks and carves out a secure and resilient path to profit. Investors must choose investments that have planned for a cross-section of risks from climate change to diminishing water availability,” he adds.
It is not just risk mitigation. Investors also need a deeper understanding of the social and environmental impacts of investment decisions. For example, Bloomberg now puts environmental, social and governance data on its terminals, accessed by 300,000 customers, including Wall Street and other analysts. Non-financial performance is becoming increasingly important. The burgeoning number of extra-financial reports requested by investors and regulatory bodies cannot be overlooked. Global initiatives such as the UN Global Compact and the Global Reporting Initiative are relentlessly driving sustainability issues ahead and reflect the change in direction when it comes to stakeholder demands.
An effective environmental, social and governance (ESG) focus will not only unveil opportunities for revenue growth from new green products and services, but reduce costs by eliminating waste and inefficiencies, for example. All of this will contribute to an improved shareholder value.
This opinion was corroborated by two McKinsey studies which showed that many business leaders also believe that sustainability can contribute to shareholder value creation. The 2010 study How Companies Manage Sustainability indicates that 76% of the surveyed executives say sustainability contributes positively to shareholder value in the long term, and 50% see short-term value creation.
Perhaps one of the most convincing studies was carried out by Harvard Business School. It compared 90 US-based high-sustainability companies with 90 companies considered as low-sustainability. The classification was based on the adoption of environmental, social and governance policies in the 1990s that “reinforced a cultural commitment to sustainability”. This included reducing carbon emissions, green supply-chain policies, energy and water efficiency strategies, diversity and equal opportunity targets, business ethics and human rights.
The high-sustainability companies adopted 40% of these sorts of measures, while the other 90 companies only adopted 10%. And, 18 years later, the former companies performed financially better, with an annual average above-market return that was 4.8% higher than the low-sustainability companies, had lower volatility and a better return on equity and assets. The research team believe they found conclusively that by improving their environmental and social performance, the more sustainable companies created higher long-term value for shareholders and acquired long-term investors.
What investors want to see
For businesses looking to attract sustainable investors, long-term sustainability transformation is crucial. Businesses looking to integrate sustainability into the DNA of their organisation must develop long-term business models with long-term objectives. With investors and stakeholders increasingly understanding the implications of these long-term goals, a longer term strategy of value creation will become crucial.
And then it’s evidence. Investors want to see relevant and reliable reports. They want to see that the company is hitting energy reduction and environmental targets, conducting thorough risk assessments and managing its supply chain. They want to see companies both shaping consumer behaviour, but also meeting the eco-conscious expectations of those same consumers. Employee engagement should also never be overlooked. A fully engaged workforce will represent a shifting company ethos and investors recognise this as a signpost to transformative sustainability.
Businesses need the courage and conviction to be aggressive and ambitious when setting sustainability goals. They need to show their investors that they are at the leading edge of corporate sustainability.
Last year, Timberland unveiled a set of new sustainability and social enterprise goals for 2015. The company pledged to reduce carbon emissions by 50%, increase its use of green power by 30% and boost the integration of recycled, organic or renewable materials for its apparel lines by 50%. It is impressive stuff and has not dented its project margins. Quite the opposite. When American brand VF Corp executed an acquisition of Timberland boots last year, it saw revenue climb 37% to $2.9 billion, with the Timberland acquisition contributing $549 million in sales. Timberland is one of many brands to challenge an antiquated and unsustainable approach to doing business. With the right investment, other businesses can join these trailblazers and shape the green economy the world so desperately needs.
Our financial system is on the move. In a 2011 report commissioned by 14 global investors, the investment consultant Mercer underlined the risks of climate change to investment portfolios and advised that investors could profit from “increased allocation to climate-sensitive assets” such as infrastructure, property, sustainable equities, agricultural land and timberland. In the New Year, Mercer published more research, and this time it showed that, in response to the first report, these investors had reacted and were now shifting their asset allocation strategies and improving engagement with companies. Transformation to a sustainable investment strategy takes time. But allocating tangible capital to sustainable innovations helps to lay the foundations for a brighter future.
About the author
Verity Hambrook is a freelance writer and communications executive, with expertise in corporate sustainability and governance.
Last reviewed 23 April 2012