Can sustainability enhance investment returns?
Often, there is the misconception that making a positive impact on society and the environment must come at the expense of performance. At EQ Investors, we firmly believe the opposite to be true. Indeed, there is ample evidence that it can boost company profitability and your long-term investment returns.
Can sustainability considerations enhance company profitability?
A fast growing number of companies globally are working towards improving the impact of their everyday operations in relation to relevant environment, social and governance (ESG) factors. These companies are gaining competitive advantages by improving efficiencies, reducing their exposure to legislative or environmental risks, upping their reputation and improving their employees’ work-ethic. All of these improvements reflect good management – and drive profitability.
One such example is Unilever, the transnational consumer good company with well-known brands like Lipton and Dove. They launched their Sustainable Living Plan in 2010, an ambitious roadmap to decouple Unilever’s future growth from the environmental footprint of their operations, while increasing their positive social impact. With profits up 40% since then, Unilever has taken advantage of its stringent approach to sustainability to strengthen the appeal of its products.
A recent study by MSCI has provided further evidence for this on a large scale, by demonstrating a strong positive relationship between companies’ ESG performance and profitability.
Does ESG investing generate better returns?
ESG investing, broadly speaking, aims to invest in companies with high environmental, social and governance (ESG) performance and avoid those that have more unsustainable business operations. Through doing so, investors are effectively decreasing the downside risks of their investments, but also capturing possible financial growth opportunities perpetuated through positive public sentiment. Through investing in better-run companies, investors are also less exposed to potential scandals.
It’s highly likely that Volkswagen’s poor ESG performance would have reduced investment exposure prior to the 2015 emissions scandal, if ESG analysis had been embedded in the investment process. Opposing criticisms of ESG, the largest review of research findings looking at the relationship between ESG integration and financial performance of investments (2,200 studies) found a positive relationship in the large majority of cases.
Even the Bank of England is urging investors to realise that one overarching ESG issue, climate change, is posing material physical, liability and transition risks to investments. We think this highlights why an ESG investment strategy is increasingly mainstreamed, to help investors enhance risk-adjusted returns in the transition to a low-carbon economy. No wonder why a recent survey by RBC showed that 84% of institutional investors now incorporate ESG analysis into their process.
Could we go further than use ESG analysis to enhance returns?
Investment returns can be enhanced through investing in companies with more sustainable operations (ESG focus), but we are certain that there is an even greater opportunity. Investing in businesses that integrate sustainability into their business purpose, reflected in their core products and services, is where the financial and ‘impact’ opportunities lie.
Impact investing aims to invest in companies that have turned pressing societal needs into profitable, long-term business opportunities. The track record of impactful investments so far shows that they have the ability to outperform conventional equivalents and that their innovative business models are highly profitable – as we show in our second annual impact report.
The UN estimates that $5-7 trillion of investment is needed annually to solve the 17 most pressing global issues (represented by the UN’s Sustainable Development Goals) by 2030. In response, the number of companies providing solutions is accelerating at a rapid rate, which in-turn is expanding the impact investment universe. As these businesses naturally focus on solving issues with a long-term impact potential, this mirrors in their long-term financial performance and growth potential.
Taking the example of healthcare companies that are working towards developing treatments for Alzheimer’s disease. This presents a huge opportunity today and in the future, with populations aging the prevalence of the disease is increasing too – from 46 to 131.5 million patients by 2050.
Impact investing solves sustainability issues and creates sustainable returns. Additionally, by focusing on sustainable solutions, impact investing avoids exposure to any companies that are incompatible with a 2-degree world (the global warming cap) and associated legislative, reputational and stranded asset risks.
As Al Gore puts it: ‘sustainability is history’s biggest investment opportunity’.
See our 2018 impact report for more information.