There have been many wake-up calls for responsible investing – from the business risks of climate change to the human and reputational damage wrought by poor labour practices.
One lesser-appreciated wake-up call was the 2008 financial crisis. The market carnage was in large part due to a failure of corporate governance within the banking industry. As such, it opened investors’ eyes to the merits of judging companies against so-called ESG criteria, which measure a business’s performance on environmental, social and governance issues. The “G” bit of the acronym highlighted the dangers of being overexposed to high-risk finance.
The episode also provided one of the first mainstream demonstrations of how pension and investment funds focused on ESG criteria can sometimes be a wiser financial investment.
Within the finance industry, the ability of ESG investments to hedge against certain risks was fairly well-known even back then, explains Mike Fox, head of UK sustainable investments at Royal London. But being well-known did not make it conventional wisdom. A lot of people then still viewed ESG investments as being primarily tied up in green activism, even though the data existed to show they could also be a profitable place to put your money.
Fox notes that it was difficult to shake people’s preconceptions. “People will literally fight not to change their opinions,” he says. “The way you often get progression is when the next generation comes along – because they are not impaired by the thinking of the previous.”
Of course, generational change is not the only reason people’s perceptions about ESG investing have shifted. Many of the climate problems which seemed quite far away only 10 years ago are happening today. In a sense, then, the long term is effectively now. “If you look at climate change, insurance premiums for some types of property have gone through the roof in the last few years, just because of the effects of flooding,” says Fox. “You are beginning to see real world climate change.” He adds that some effects of the climate crisis, such as drought and wildfires in California, are not necessarily new, but they are now front-page news.
And even when it comes to the more long-term threats, businesses that put climate risk at the forefront of their strategy and decisions are effectively taking a longer-term view of their market than businesses that don’t. This arguably sets their managers apart from those who prioritise short-term profits and earnings targets. That longer-term perspective in itself can make for an attractive investment – particularly for long-term investors, such as pension holders.
Moreover, people’s changing perception and their realisation that sustainability is the key to a liveable future can have a material impact on a company – whether through higher demand for its products or its shares, or stronger goodwill for its brand. “If you’re a consumer company, the biggest single group of customers is now millennials and if you’re targeting them, having positive, sustainable characteristics is good for business,” says Fox.
Indeed, according to the Co-op’s 2020 Ethical Consumerism report (pdf), between 2010 and 2019, ethical consumer spending in the UK rose from £46bn to £98bn.
A company’s long-term sustainable or ethical perspective can also have a present-day impact on its employees. Increasingly, people want to work for businesses whose values reflect their own – whether it be on environmental issues, treating their workforce well or linking CEO pay to performance. A 2017 survey (pdf) by Deloitte found that millennials were more likely to be loyal and stay more than five years (34% v 24%) at a company that provided charitable opportunities than one that didn’t.
In addition, there are issues around future regulation and legislation – companies that take ESG factors into account will likely be better placed to deal with new laws as and when they come into force. By contrast, those that fail to take adequate steps on ESG issues will not only be more susceptible to regulatory risks, they might also have to pay more for insurance, and their access to capital could be costlier. Likewise, they may even find that other companies’ ESG policies prevent them from doing business with them.
“There’s a complex set of pushes and pulls behind anything like this,” says Julia Fawsley Grant of ESGmark, an organisation that promotes and recognises ESG in business. “This has been building for a long time. More and more companies are realising that if they don’t have a robust ESG policy, people will stop investing in them and will stop buying from them.”
This is not to say that companies that currently score poorly on ESG metrics have no future – just that they will need to become more sustainable in order to continue to be successful. “If you look at companies like Shell and BP, if they’re clever about it, they can move into biofuels and hydrogen and renewables. If they do that, they have a very bright future ahead of them,” says Fawsley Grant. The oil companies, she adds, may also play a big role in the future in carbon capture and burial technology – in effect, cleaning the mess they helped to make.
Fox says that, ultimately, sustainable business is just good business. “We already have large wealth management clients for whom the default approach is a sustainable approach. It’s not because they’re following some environmental mantra – it’s because they think they’re going to get a better return.”
Learn more about responsible investing by heading to Royal London – The Invested Generation
