by: Nawar Alsaadi
A column designed to help you understand the link between ESG factors and potential investment outcomes.
The fact that responsible investing is closely intertwined with a multitude of social, environmental and governance developments introduces a need for timely and actionable ESG analysis, something this new column is intended to address. Many investors are familiar with economic news and statistics, but may be perplexed, or unable to connect the dots, when it comes to social and environmental developments that might seem remote from the investing field and yet are deeply connected to it. For that I cite issues such as the growing wealth divide in our society, the worsening climate and environmental crisis, and the erosion of truth amid the proliferation of fake news and misinformation. At first glance such matters might appear disconnected from the world of business, but I assure you the truth is anything but.
The legacy of separating social and environmental trends from business stems from a historic stance, now discredited, that believes wealth creation is purely financial in nature, and that worrying about externalities such as employment income and social inequality, women’s rights, a warming climate, and/or diminishing biodiversity is not relevant to business. Back in the early 20th century, U.S. President Calvin Coolidge said of America, the world’s fastest growing economy at time, “The chief business of the American people is business.” The view that business reigns supreme was the dominant view throughout the 20th century, a view personified by the famed economist, Milton Freidman, who asserted during the 1970s that when it comes to corporations, the interest of shareholders supersede the interests of all other stakeholders.
Today, such narrow notions are frowned upon, not just because of their questionable morality, but because it has become abundantly clear that business cannot prosper in a collapsing natural environment, rising inequality, and increased social marginalization. A landmark 2014 study on inequality and economic growth by the Organization for Economic Cooperation and Development concluded that rising inequality in OECD countries has contributed to 0.35% annual decline in the economic block’s growth potential, or approximately US$175 billion in lost annual economic growth due to declining social mobility, diminishing social capital, and reduced educational opportunities.
Likewise, the United Nations estimates the annual economic adoption cost of climate change to reach between $140 billion and $300 billion by the end of the decade, and between $280 billion and $500 billion by 2050. What these numbers indicate is that social issues and environmental issues are as much economic and business issues as they are ethical issues, and that for companies to thrive and prosper they need to factor in and mitigate the social and environmental consequences of their operations.
Source: Organization for Economic Cooperation and Development website.
This growing understanding of the strong linkage between traditional and non-traditional business factors is the bedrock of the ESG investing movement, a movement which attempts to capitalize on and further catalyze the convergence of business and environmental, social and governance factors.
ESG investing strategies built to capture this convergence have been shown to outperform traditional investment strategies. A 2019 study by Sandford Global Projects Center concluded that an investment strategy that was long carbon-efficient firms and short carbon-inefficient firms had produced 3.5-5.4% excess annual returns. Meanwhile, numerous studies have demonstrated superior return on capital and increased profitability for companies with three women or more on their boards. Furthermore, an extensive 2018 study published by the European Corporate Governance Institute concluded that successful engagements on environmental, social and governance issues lead to between 3% and 22% sales growth in the year following a successful engagement. This symbiotic relationship between wealth creation and strong corporate sustainability performance sits at the heart of our responsible investment policy: “NEI Investments is committed to helping our clients grow wealth while advancing the Environmental, Social and Governance (ESG) performance of publicly-traded companies wherever we invest.”
When Ethical Funds (NEI’s predecessor) launched its first socially responsible fund in 1986, the relationship between business and ESG factors was far less apparent than it is today. Yet, ever since our beginning, we believed the key to superior, sustainable, and durable investment performance lies in fully incorporating non-traditional business factors in the investment process, and in utilizing our rights as shareholders to engage with companies to improve their sustainability profile.
As we go forward, this column will give you a firsthand look at how we look at that world from a dual lens of doing well and doing good. And how our drive for enhanced corporate social, environmental and governance sustainability informs, guides, and enriches our investment process. Sharing these insights will offer you an opportunity to become a better investor by fully incorporating ESG risks and opportunities in your investment process.