A recent survey shows many don't understand that a company's high score on social responsibility indices also signals good risk management
Nearly 70% of fund managers still do not regard it as standard practice to factor environmental, social, and corporate governance initiatives into their investment decisions. That was the headline finding of a recent survey of 40 institutional investors undertaken by the advisory firm Maplecroft, of which I am a director, on behalf of logistics and transportation company TNT (TNT.AS) and the World Economic Forum.
Not surprisingly, what investors do factor into their decisions is proficiency in risk management. They prefer buying into companies that have clearly identified problems potentially affecting future performance—everything from the impact of carbon emission regulations to whether HIV/AIDS rates in some countries could limit the availability of staff. Investors look even more favorably at companies that have developed strategies to mitigate the identified risks.
But the fact that investors value good risk assessment more than corporate programs aimed at addressing environmental, social, and governance (known as "ESG") issues is a curious disconnect, because in many respects they're two sides of the same coin. After all, ESG issues can have serious cost implications for business—and thus need to be considered in any risk-management context.
How to Find ESG-Sensitive Equities
The conclusion from our study was twofold. First, to the extent fund managers don't pay as much attention to ESG as they do to risk management, they are losing the ability to perceive long-term challenges facing their investments. And second, companies that are leaders in sustainability—broadly defined as paying close attention to the environmental, social, and human impacts of their activities—aren't always succeeding at communicating to investors the depth of their risk assessment and the management procedures they have in place.
There is an easy shortcut to better understanding. Socially responsible investors already employ specific ESG screens for picking stocks. But there are also a variety of sustainability benchmarks and indices available to mainstream investors, such as the Dow Jones Sustainability Index (DJSI), the FTSE4Good, and the Business in the Community (BITC) Index, that do a rigorous job of screening companies for inclusion based on criteria such as corporate governance, risk and crisis management, eco-efficiency, environmental reporting, and labor practices. Only companies with the most robust non-financial management systems can achieve these high standards, so inclusion in the indices is an excellent proxy for sustainability.
What the majority of investors don't seem to appreciate is that being included in sustainability indices like the DJSI also speaks volumes about a company's risk management proficiency. Indeed, one would think high scorers should be regarded as "must-have" investments for that reason alone. Instead, mainstream investors aren't grasping the fact that high performance on sustainability indices usually implies a company is better than most at assessing and managing all kinds of risk.
A Reporting Gap
Some of the blame falls back on companies. Many rely on their annual corporate responsibility reports to showcase initiatives designed to address environmental or social risks. Yet none of the fund managers interviewed by Maplecroft said they read these. This creates a reporting gap that companies need to address if they want their long term risk management proficiency to be recognized by shareholders. In particular, they should explain the business case for ESG initiatives in the language of risk and risk management—not just as a social good—and report on these risks alongside financial figures as part of their annual reporting process. Few companies are doing this now, though TNT says it will start this year.
Of course, some investors do recognize that ESG risks exist. When asked to identify priorities, they cited energy efficiency, protection of labor standards, health and safety, and human rights. Some 70% of the investment firms we surveyed are members of the Carbon Disclosure Project, which means they acknowledge the relationship between shareholder value and climate change and have made commitments with respect to their performance and activities. In addition, 52% are signatory to the UN Principles for Responsible Investment and 42% to the UN Environment Program Finance Initiative.
Yet there was not high awareness among mainstream investors about the extent of their organizations' adherence to or implementation of these principles. And more worrying, respondents had no awareness of the extent to which companies with strong performance on sustainability indices might be considered superior investments on the grounds their results demonstrate to investors that they have met their commitments.
Stakeholders Have Differing Views
For companies such as TNT, which is a Dow Jones Sustainability Index "Super Sector Leader," this makes interesting reading. "These findings cause us to take a long hard look at how we communicate our sustainability initiatives, especially the hard work we have done to achieve emissions accounting and reporting alongside our financial accounting," said Chief Executive Peter Bakker after he learned of the findings. "We communicate these in terms of business risk mitigation, not just saving the planet, even though the two are becoming the same. We will continue applying our logistics skills to humanitarian initiatives, as food security and disaster response are the right things for us as a global corporate citizen to address."
Curiously enough, the views of shareholders and investors contrast sharply with those of other stakeholders such as employees, customers, and suppliers. Survey work we've done in recent years for the logistics and transportation industry found specific issues such as health and safety, labor standards, and carbon emissions as the burning issues for reporting and accountability. Indeed, each stakeholder group tends to perceive dangers and accountability differently. Risk, like beauty, still lies in the eyes of the beholder.