Company executives and institutional asset managers are increasingly working sustainability into their strategy and operations. Similarly, institutional asset managers are doing the same in constructing their portfolios. Yet both groups are doing this relatively independently of each other. These two groups should and will be seeing more of each other as sustainability matures.
As it stands, engagement between executives and institutional investors is limited to stylized interactions, such as quarterly calls, investor visits, and annual meetings. These interactions involve a small number of people representing each side of the conversation -- executives on the company side, and portfolio managers and analysts on the investor side. Substantive discussions about the long term almost never happen. They should.
Better communication can reconcile their competing missions and working definitions of sustainability. For investors, it’s about returns that exceed as much as possible the company’s cost of equity capital, with minimal risk that a company’s negative environmental or social externalities will come back to haunt them. For companies, it’s about the need to create value for shareholders in a way that creates value for other stakeholders as well -- with the recognition that tradeoffs are inevitable, especially in the short term.
We’ve seen firsthand how valuable it is to bring them together. This spring we launched an executive education program, called “Innovating for Sustainability” in Hampshire, England. Forty executives attended from 24 countries and from about as many industries. The course focused on how to avoid trade-offs that present themselves when executives try to simultaneously improve financial performance and nonfinancial performance across environmental, social and corporate governance (ESG) metrics. Sustainable companies can score high on all measures. It’s not easy, but it’s possible.
On the corporate side, a detailed and rigorous business case needs to be made that moves beyond the high-level rhetoric that sustainability is just good business. Which specific issues are most material for the business strategy of the company? How do they add to or detract from value creation, and over what time frame? What are the key tradeoffs that exist between financial and nonfinancial performance? How can these be reduced through innovations in processes, products, and business models?
Sujit Ghosh, a participant in our program, is managing director and CEO of Holcim Singapore Pte Ltd, an affiliate of concrete and cement manufacturer Holcim Ltd. He said he learned from the conference that asset managers are eager to learn more about business sustainability, but communication has been lacking. “Investors of today are highly sophisticated, well informed, and highly demanding. Not only they seem to care about immediate financial performance, but are looking for more information from companies to evaluate their longer-term prospects and business-sustainability,” Ghosh said after the conference. “I realized how little they know about Holcim’s global sustainability efforts and how these are core to the company’s strategy. Clearly this calls for stepped up and improved communication and engagement from our side with the investor community.”
For their part, investors and analysts can learn whether to take a company’s long-term strategy and commitment to sustainability more seriously when they hear executives’ motivations for undertaking it in the first place. Fund managers and analysts from both the buy side and the sell side should move beyond their use of valuation models that use only financial information to project a company’s future cash flows and stock price. They should also move beyond their reliance on quarterly numbers in assessing the future profitability of the company. Better information about a company’s sustainability strategy will allow investors to better forecast both the future profitability of the firm and its riskiness. Although such an exercise requires a wider range of skills than currently held by most investors, the acquisition of these skills will lead to better resource allocation decisions.
Sustainability takes a long time for companies to develop and implement, and requires creativity. Angelica Ortiz de Haas is sustainability manager at FMO, the Dutch Development Bank. She explained how she and her colleagues encourage the financial sector to take a longer-term view: “The investment community can change the beat of the markets. Most of the sector is playing at the beat of quarterly results and this short-term approach is in tension with long-term considerations. If the financial sector were to focus more on long-term results, we could see a complete change of dynamics in the markets. The financial sector can play a leading role in changing the markets by offering knowledge and products to support clients in becoming more sustainable. One of the innovations FMO has introduced in our markets is a pricing incentive. This incentive consists of a few basis point for either reducing their risk by addressing sustainability issues or because they add value to society by introducing innovative ideas on how to add value from an environmental, social or governance aspect.”
That’s what sustainability is all about: Generating benefits for both shareholders and society at large.
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