Putting Responsible Practices into Play

Evaluating ESG—­environmental, social, governance—is necessary for business today

In recent years, ESG has become a popular topic of conversation in the corporate and investment worlds, and it is becoming increasingly difficult for companies to deny the benefits of incorporating Environmental, Social, and Governance criteria into their business practices. Although previous beliefs posited that ESG considerations related only to societal and ethical issues, forward-thinking companies have discovered that ESG values also impact a company’s finances, reputation, and long-term growth. Furthermore, using ESG criteria is not only morally beneficial, it is also now a factor in institutional and high-net worth investors’ allocation decisions.

Universal ESG standards exist to evaluate companies’ operations. The first letter in the acronym, E, considers how a company interacts with the physical environment. The second stands for social, examining how a company manages relations with its employees, suppliers, customers, and their communities. Governance, the third letter, contemplates and reviews a company’s leadership, executive pay, audits, internal controls, and shareholder rights.

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Broadly speaking, investors have been putting more emphasis on identifying opportunities with firms that engage in sustainable practices and demonstrate conscientious ­behavior, both within their own walls and in the communities in which their investments have real, tangible impacts. Although there have been some mixed attitudes regarding the long-term impact of ESG standards in business practices, it is increasingly obvious that monitoring and policies around sustainability and corporate responsibility are no longer viewed as optional for businesses but should instead be regarded as a necessity.

Shifting Positions Around ESG

Data from the 2018 survey conducted by the Morgan Stanley Institute for Sustainable Investing reveals that sustainable investing is gaining an increasing amount of value and recognition among businesses, investors, and institutional asset owners. The study shows that globally, more than $22.8 trillion is now sustainably invested, a sum that represents 25% of dollars under professional management.1

The 2018 Morgan Stanley survey polled 118 public and corporate pensions, endowments, foundations, sovereign wealth entities, insurance companies, and other large asset owners worldwide, gathering insights about trends, motivations, challenges, and implementation approaches in sustainable investing.

Data showed that approximately 84% of companies are now pursuing ESG integration in their business activities, while 60% have been doing so for the past four years. Numbers like these highlight the increasing popularity of corporate responsibility and conscientiousness, with increasingly more companies acknowledging the benefits of implementing ESG practices into everyday processes.

Although the survey responses do reveal a gap between interest and implementation, these results show vast improvement in the value businesses now place on ESG practices. Sustainable investing was previously perceived as a niche investment idea but now receives credit for having positive effects on factors such as risk avoidance and company growth.

Recent trends show that corporations are also becoming more transparent about their ESG practices. Practices such as annual ESG or corporate social responsibility reporting create an advantage for asset managers who are able to capitalize on current opportunities, such as using above-market ESG performance among portfolio holdings as a selling point to potential investors.

Since 2011, dedicated ESG disclosures in the corporate world have grown at an exponential rate. From 2011-2015, ESG reporting among S&P 500 companies increased by values of 20%, 53%, 72%, 75%, and 81%, respectively.2 These figures testify to the fact that corporations face mounting pressures from ­institutional shareholders and the general public on ESG issues, such as corruption and environmental ­sustainability.

Data showed that approximately 84% of companies are now pursuing ESG integration in their business activities, while 60% have been doing so for the past four years.

The Newest, Most Valuable Player for Companies

Although ESG criteria is often considered to hold ethical or social responsibility values, it is becoming clear that companies with stronger employee relations and environmental sustainability practices often also demonstrate better financial performance in the long run.

A recent meta-analysis by the University of Oxford analyzed approximately 200 studies to assess how sustainable corporate practices have affected investment returns. The results showed that operational and stock price performance is positively influenced by good sustainability and ESG practices 80% of the time.3 Additionally, the Morgan Stanley report 3 revealed that consumer purchase trends favor products from businesses with socially conscious or sustainability inclinations. Approximately nine in 10 (87%) of U.S. consumers admit to purchasing a product because of a company’s stance on an issue they care about.

Despite this correlation between sustainable investing and financial performance, there is still progress to be made in changing perceptions regarding the value of implementing ESG into business practices. The 2018 study showed that 57% of investors surveyed still believe investing sustainably requires a financial trade-off of some sort, thus making this framework seem less desirable.4 Such beliefs are beginning to fade, however, as more and more business owners and investors recognize the unique insights ESG provides into long-term risks and opportunities.

A Top Pick for Investors

Progressive companies have realized that ESG can be made an asset if practices are made transparent. By integrating ESG standards, companies are able to establish a competitive advantage when seeking investment. Companies that incorporate ESG factors into their long-term strategic planning can communicate this to shareholders and give a more thorough picture of their company value.

By investing in companies with strong ESG principles, investors avoid the risk of suffering related losses. Examples of this are BP’s 2010 oil spill and Volkswagen’s 2015 emissions scandal, both of which negatively impacted the firms’ stock prices and resulted in billions of dollars in market capitalization declines. Instances such as these strongly suggest incorporating sustainable business practices not only helps improve long-term performance but also mitigates risk and positively shapes brand and reputation.

Sustainability in Action

As more companies begin to implement ESG frameworks into their practices, the overall investment process among global asset owners is becoming increasingly sophisticated. More than 80% of institutions integrating sustainability criteria now rely on request for proposal (RFP) processes and Investment Policy Statements to measure and ensure a company’s commitment to sustainability objectives.

When Environmental, Social, and Governance criteria are measured alongside financial analysis, the two methods of analysis can produce a clear picture of risk and return. This can prove to be beneficial to businesses, as ESG integration is often focused on identifying long-term risks and capturing opportunities arising from sustainability trends.

Another approach to ESG investing is thematic investment strategies. Used by 81% of survey respondents, these strategies involve investors choosing to allocate capital based on themes and sectors dedicated to specific ESG issues. For instance, the top thematic investment in the Morgan Stanley survey was climate change, with 44% respondents seeking to address these issues or to invest in companies already addressing climate change adaptation and mitigation.5

Moving Forward With ESG

The growing interest in ESG business practices reflects the view among companies and shareholders alike that integrating this set of criteria into investment processes can have positive benefits that extend beyond ethics and social responsibility. ESG integration seeks to not only effect positive change within communities and the environment but also serve as a strong foundation for the long-term financial success of an organization or company. Responsibility and profitability are no longer seen as incompatible concepts but in fact as wholly complementary, and we can no longer deny the benefits of adopting ESG-centered business practices.

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