Exercising power: Investors’ sights set on sustainability

Investors are slowly realising that sustainability issues can impact returns. While the volume of assets under sustainable management is growing, implementation is slow and money is not shifting in the right direction fast enough.

Global capital markets have made significant progress on responsible investment
since 2000. The volume of assets under responsible management has increased
dramatically, and the sophistication of responsible investment practices
has developed markedly. Driven by an emerging appreciation of how sustainability
and governance affects long-term profitability, there is greater awareness
amongst investors of their responsibility to manage these risks for their clients.


RESPONSIBLE INVESTMENT: A WHOLE NEW BALLGAME
In the early 2000s, the recognition that sustainability issues were potentially
material to returns started to emerge. Around 2004, investors began adopting
the term ‘ESG integration’ to denote the systematic inclusion of environmental,
social and governance factors into traditional financial analysis. However,
negative screening and ‘blacklisting’ of high risk sectors continues to be the
dominant approach, and there have been claims the financial sector is lagging
5-6 years behind business in terms of understanding the materiality of sustainability.
Over the past 15 years, responsible investment has gradually moved from
being solely linked to listed equities to being considered in a whole range of asset
classes, including fixed income, private equity, property and infrastructure.
However, the maturity of approaches varies significantly between asset classes.
In terms of policy, there has been an increase in measures requiring investors
to exercise their rights and responsibilities as owners. One prominent example
is the UK Stewardship Code of 2010, which aims to enhance the quality of
engagement between asset managers and companies to help improve long-term
risk-adjusted returns.


DRIVING BETTER DISCLOSURE
Disclosure of companies’ material non-financial performance currently
represents a significant challenge for investors. With no standardised metrics
adequately translating the language of sustainability into the language of
finance, the quality of the data investors use to make projections and forecasts,
and compare company performance, is weak. Investors are increasingly pushing
companies to be more transparent on ESG risks, and to a lesser extent opportunities,
especially if these are material to asset value. They are also increasingly
demanding reporting based on recognised standards for assurance and trust,
and some groups are actively engaging in initiatives to develop standardised
metrics.


A NEW ERA: FROM RISK MANAGEMENT TO IMPACT?
While some investors have started to incorporate ESG factors into traditional
financial analysis, many investors have also become interested in ‘impact’ investing
- investing in companies or funds with the aim of generating social and
environmental benefit in addition to financial return.

Impact investing has grown to a market of around €20bn. With a growth
rate of 132% from 2011 to 2013, it was the fastest growing responsible investment
strategy in Europe. The findings compiled for this report suggest that more
investors will shift from risk-based approaches to more proactive strategies in
the coming years.

CASE EXAMPLE: THE GLOBAL COMPACT 100 INDEX

A sustainable bottom line: The Global Compact 100 Index - Cumulative Total Return (in US dollars) since inception

The Global Compact 100 is made up of a representative group of Global Compact companies. The index does not look at performance solely in terms of basic financial health, but combines corporate performance on environmental, social and
governance issues with a requirement of consistent base-line profitability. Unveiled in
2013, it showed a total investment return of 21.8% by the end of its first year.

THE ROLE OF THE GLOBAL COMPACT:
BRINGING IN MAINSTREAM INVESTORS

The Global Compact started involving the investor community in the dialogue
around corporate sustainability performance very early, and was among the first
to recognise the importance of capital markets in fostering sustainable business.
As such, it can be seen as instrumental in helping change mainstream investor
attitudes on ESG issues.

In 2004, the Global Compact brought investors and businesses together in
the initiative ‘Who Cares Wins’ which sought to embed environmental, social
and governance issues in capital markets. At the same time, the UNEP Finance
Initiative launched ‘The Materiality of Social, Environmental, and Corporate
Governance Issues to Equity Pricing‘, outlining how ESG issues could be
integrated into mainstream investment analysis. Together, these two initiatives
helped shift the approach away from negative-screening and blacklisting towards
integration. They also helped catalyse thinking in the mainstream investment
world, that better management of ESG risks can enhance competitiveness
and generate longer-term value.

These developments laid the grounds for the creation of the Principles for
Responsible Investment (PRI), which was launched at the New York Stock
Exchange in April 2006. Through the PRI, the Global Compact has exercised
influence on companies far beyond their signatory base (see Spotlight on PRI
for more details).


SUSTAINABLE STOCK EXCHANGES: CHANGING THE HEARTBEAT OF FINANCE

The Global Compact is also one of the four UN organisers of the Sustainable
Stock Exchanges initiative, a peer-to-peer learning platform for exploring
how exchanges can encourage sustainable investment and enhance corporate
transparency. Stock exchanges can join the initiative by making a voluntary
public commitment to promote ESG disclosure and performance among listed
companies.

Today, 31 per cent of all publicly listed companies are traded on a Partner
Exchange to the Sustainable Stock Exchanges initiative. This covers 18,000 out
of the world’s 45,000 listed companies. Forbes has named the Sustainable Stock Exchanges initiative one of the “World’s Best Sustainability Ideas”.

“The problem with focusing only on risk
is that it can be seen by investors as window-dressing or box-ticking, rather than focusing on the future of the company. Focusing on the future means looking for an aspirational opportunity to align a corporation with its shareholders, based first on the outlook for
profitability, and then ultimately global economic growth.”
ERIKA KARP, FOUNDER & CEO, CORNERSTONE CAPITAL GROUP