ESG Performance Now Mainstream Driver for Shareholder Value

This blog is the first in a multiple-part series to help Sustainability and Operating Executives move from a finance-approved business case that is predominantly independent cost- and payback-centric to a more holistic, value-centric business case for an integrated ESG Strategy to advance Corporate Sustainability that wins approval by the CEO.

Sustainability Roundtable Inc (SR Inc) has had the privilege for more than 10 years to work with over 75 leading corporations and enterprises on advancing their Corporate Sustainability strategy.  In that time, we have seen our member-clients’ individual and collective progression in elevating Corporate Sustainability from a cost center focused on efficiency and supply chain to more of a value center based upon contributions to profit and growth.  The below chart reflects this advancement of SR Inc member-clients’ collective practices regarding Corporate Sustainability Vision & Governance and Strategy as confidentially benchmarked in SR Inc’s Sustainable Business & Enterprise Roundtable (SBER) Assessments.

This progression is affirmatively punctuated by NASDAQ becoming one of SR Inc’s new member-clients in 2018.

The evidence highlighted below both reflects and strengthens those efforts by:

• Reflecting the investment community’s widespread adoption of ESG investing
• Suggesting that in the next several years, reported ESG performance will become as prevalent a consideration as Income Statements, Balance Sheets, and Cash Flow Statements in impacting your company’s stock price (or valuation, for private corporations)
• Placing responsibility for a company’s ESG performance squarely on the shoulders of the CEO

As Larry Fink, CEO of BlackRock, the world’s largest investor with over $6 trillion in AUM, said in his Annual Letter to CEOs: “I want to reiterate our request . . . that you publicly articulate your company’s strategic framework for long-term value creation and explicitly affirm that it has been reviewed by your Board of Directors.”

To understand why the professional investment community has determined that strong reported ESG performance produces a clear market signal for superior future risk-adjusted returns, we turn to the evidence.

In 2018, the ratio of US professionally managed investor funds that incorporate ESG performance into investment decisions has grown to $1 in every $4 – that’s $12 trillion tied to ESG performance.¹ Moreover, those $12 trillion are growing much faster than their counterparts (at 18% annually since 2014, with the largest component of environmental funds doubling since 2016). Given, that trajectory, it is likely that the ratio will be closer to $1 in every $3 by 2020.  Further, the maturity of ESG investing is evidenced by Larry Fink’s projection that ESG EFT investing will grow at over 25% a year for the next 10 years. In the same Annual Letter to CEOs referenced above, Fink asserts, “A company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process.”

So, why the dramatic increase in ESG investment in recent years?

Unsurprisingly, because evidence of ESG investing’s financial benefits is frankly overwhelming. One does not get professional investors to change their investment strategies and algorithms without some compelling evidence. To that end, I list below just a sampling of what is available today that has informed those investors:

A review of over 200 investor and academic studies demonstrated that²:

• 90% of the studies on the cost of capital show that sound sustainability standards lower the cost of capital of companies
• 88% of the research shows that solid ESG practices result in better operational performance of firms (e.g. 67% higher ROE)
• 80% of the studies show that stock price performance of companies is positively influenced by good sustainability practices

Some additional key quantitative and qualitative data investors cannot ignore:

Quantitative

• Through trading strategies, which go long in acquirers with a better sustainability profile and go short in acquirers with a worse sustainability profile, investors can realize an annual risk-adjusted alpha of 4.8%, 3.6%, and 3.6% over 1,2 and 3-year holding periods, respectively³
• A ‘high-sustainability’ portfolio outperforms a ‘low sustainability’ portfolio by 4.8% on an annual basis⁴
• Evidence in a prior SR Inc blog, Corporate Sustainability as a More Strategic Approach to Management Gets a Shot in the Arm, determined that high ESG performance, particularly on “Material” factors, led to at least 4.2% higher risk-adjusted annual shareholder value growth than companies with only ROI criteria or poor performance on ESG
• The MSCI ESG Leaders EM index has outperformed the regular MSCI EM index in the last 1, 3 and 5 years, with the 5-year outperformance being 2.43% per annum (at just 13 BPS higher volatility)⁵

Qualitative

• A recent PWC study recently concluded “sustainability is emerging as a market driver with the potential to grow profits and present opportunities for value creation — a dramatic evolution from its traditional focus on efficiency, cost, and supply chain risk”⁶
• Taking effect in 2017, mandatory non-financial reporting on issues including sustainability was adopted by the European Union with the amendment of EU Accounting Directive by the NFR Directive (2014/95/EU) on October 22, 2014
• The SEC is currently considering changes to Regulations S-K that include material sustainability disclosures, potentially engraining sustainability into the annual fillings of publicly traded companies in the U.S.

… and the list goes on.  These point to the empirical conclusion that investors can earn an alpha by investing in firms with a superior sustainability profile. Alpha is THE goal for investors, which explains why 1 in every 4 professionally managed dollars in the US today is, in part, based on ESG performance.  In the next installment of this series, we will take a look at the way companies today, including many of our member-clients, are positioning themselves to capture this significant, previously under-appreciated, source of strategic shareholder value.

1 US SIF. 2018. Report on US Sustainable, Responsible and Impact Investing Trends.

2 Clark, G.L., Feiner, A., Viehs, M. 2015. “From the Stockholder to the Shareholder: How Sustainability Can Drive Financial Performance.” https://arabesque.com/research/From_the_stockholder_to_the_stakeholder_web.pdf

3 Ibid.

4 Ibid.

5 https://www.msci.com/msci-esg-leaders-indexes

6 Clark, G.L., Feiner, A., Viehs, M. 2015. “From the Stockholder to the Shareholder: How Sustainability Can Drive Financial Performance.” https://arabesque.com/research/From_the_stockholder_to_the_stakeholder_web.pdf

David Osborn is an accomplished corporate sustainability advisor serving dozens of SR Inc’s Fortune 500 and mid-sized client companies as they drive significant operational efficiencies and better align with talent, customers, investors, and regulators through corporate sustainability strategy. From his career in business consulting and executive leadership, David brings to SR Inc over 25 years of experience in building professional services and technology-driven businesses serving a broad range of client industries. David graduated from Dartmouth College with multiple  academic honors highlighted by a citation in mathematics from the then college President John G. Kemeny.  David also graduated from Northwestern’s Kellogg Graduate School of Management with honors, a member of the Beta Gamma Sigma Honor Society and in the top 3% of his class.

After receiving his MBA, David cut his teeth at Bain & Company in their Boston office and then progressed up to Managing Partner at Booz, Allen & Hamilton (BAH) where he was ultimately elected by his Partners to head their Australasian business. After helping to grow that business from a very early stage to a staff of more than 100, David returned to the US to head BAH’s Retail Financial Services practice in North America. After a few years back in the US market, David transitioned to serve as Managing Partner / EVP at two innovative business service companies: the first a 150 employee, VC-backed innovative technology services provider in Boston, and the second a high-end, 200+ employee proprietary marketing services provider located in Princeton and New York. In both companies, David led over 200% growth within 2-3 years while substantially building the companies’ delivery teams, capabilities and shareholder value

As Senior Manager of Research & Consulting, Kelsey Wallace supports members of SR Inc’s confidential, strategic advisory & support service in their move to more sustainable high-performance. With several years experience at the intersection of business and sustainability, Kelsey provides specialized program assistance to clients on a one-to-one basis, supporting all aspects of strategy development and implementation for management teams overseeing corporate sustainability strategies, policies and projects. Prior to joining SR Inc, Kelsey worked for The Cadmus Group, where she provided technical support to the Environmental Protection Agency and US Green Building Council on projects to improve the sustainability of federal infrastructure. Kelsey also devoted a year to national service with the AmeriCorps National Civilian Community Corps, where she worked on team-based conservation and community development projects throughout the Southwest United States. Kelsey has her B.A. in Environmental Studies from Connecticut College.