In the fourth part of our 'As If People Matter' series, we take the investor's perspective, as they too try and make sense of a changing world.
Chairman of Generation Investment Management, &
Former Vice President of the United States.
It has taken four long, arduous years for the US stock market to recover its value after the financial crash of 2008. In the UK the FTSE has yet to fully recuperate. This has not been a good time to be an investor. OK, many still have enough cash and good lifestyles, at a time when many other businesses, people and families have been struggling merely for survival. But investors play an important part within our capitalist economic machine; they keep the wheels oiled and moving, so that jobs are created, salaries paid, lives can be lived. If they are not functioning in the right way, it is also hard for the rest of us to do so.
Investors too are getting to grips with how best to operate within a volatile twenty-first century economy. Questions abound. What does a good investment look like in a resource constrained, rapidly changing, and unpredictable world? What should one invest in: clean tech and renewables, or conventional industries? How certain are we of getting a return? What are the risks? What are the new rules? What is the new normal? It is certainly part of the human condition to believe that our experience of past events provides us with a realistic predictor for future outcomes. But we probably look to our old roadmaps, more in hope, than in true certainty during this time of change.
And the challenge is not just for individual or institutional investors, but also for companies and how they invest and reinvest, too. A recent McKinsey Global Survey found that most executives believe their companies are under-investing, and even missing out on worthy opportunities, due to fears around market volatility. The tragedy is not just the missed opportunities for individual companies, but also how a lack of investment over time can adversely affect whole economies, along with job creation efforts as well.
There is some good news out there, which can help investors establish the principles they sorely need in navigating towards sustainable investment success. According to a recent study by Harvard Business School, sustainability-focused companies significantly outperform traditional firms in terms of both stock market and accounting performance. 'Taking a long-term view' is cited as the key enabler for this success; not usually a feature associated with investors, or business in general, either.
One of our recent case studies provides a useful insight into the relationship between sustainability, business performance, stock value and taking the long-term view. Life Technologies, a global biotechnology tools company, has seen its stock price generally take an upward trend over the last five years, outperforming the NASDAQ Top 100 by around 8%, and the entire index by around 30% during this period, despite the general volatility in the market since the onset of the global financial crisis in 2008.
The key to investor confidence is, of course, providing year on year growth and high quality of earnings, and Life Technologies continues to deliver on both counts: in 2010 the company experienced 9% growth in revenue and 17% growth in earnings per share. This level of business performance is itself underpinned by what the company calls Radical Efficiency: a range of business improvement initiatives, including the integration of sustainability principles.
Each year, sustainability initiatives contribute an increasing amount to Radical Efficiency performance, and could represent the major share of efficiency savings for Life Technologies within 5-10 years. It is also clear that the contribution of an increasingly sustainable product portfolio will provide a greater contribution towards growing the top-line.
For Life Technologies, radical efficiency takes a long-term perspective, seemingly at odds with the very short-term demands of shareholder capitalism. Despite this apparent tension, investors are slowly becoming more sensitised to the importance of sustainability issues and their direct impact on long-term investment performance.
Any good investment of course relies on a robust assessment of the business model, and how money will be made and sustained. Investors need to be mindful of the full range of factors to be included in the investment decision. Conventional approaches here are coming under increasing strain, as the era of abundant and cheap resources draws to a close. Investors need a new lens through which they can evaluate potential investments and avoid the risks of stranded assets, i.e. those investments whose value could be dramatically influenced when major externalities, such as the price of carbon or water, are taken into account.
Indeed, ecosystem degradation is becoming an increasingly serious and expensive concern. According to a study commissioned by United Nations Environmental Programme Finance Initiative (UNEP FI) in 2010, environmental damage caused by human activity in 2008 was estimated to be $6.6 trillion, equivalent to 11% of global GDP. A huge economic impact that cannot be ignored.
The significance for institutional investors is their exposure to rising environmental costs that contribute to economic and market risks, which can affect asset values and investment fund returns. It is naturally in the interests of investors to reduce the risks and costs associated with externalities within their investment portfolios. The risks to investor funds are not just the direct environmental costs; future cash flows and dividends could also be impacted by reduced productivity and increased input costs, such as higher taxes, levies and insurance premiums. Further impacts could include falling revenues, unplanned capital investments and increased costs of capital driven by higher risks and lower potential returns.
UNEP FI provides some useful guidance for investors, for their direct consideration, but also to help influence the necessary systemic change:
1. Evaluate impacts of investee companies on natural resources.
2. Incorporate information on environmental costs and risks into engagement and voting initiatives and seek to reduce environmental impacts of portfolio companies.
3. Join other investors and engage collaboratively with companies through platforms such as PRI Clearinghouse to address key issues.
4. Engage individually or collaboratively with public policy makers and regulators to encourage policies that promote the internalisation of costs and establish clear regulatory frameworks.
5. Request regular monitoring and reporting from investment managers on how they are addressing fund exposure to risks from environmental costs and how they are engaging with portfolio companies and regulators.
6. Encourage rating agencies, sell side analysts and fund managers to incorporate environmental costs into their analysis.
7. Support further research to build capacity and improve understanding of the relationship between corporate externalities, ecosystem goods and services, company financial risk and portfolio returns.
Further support for change in the investment model comes from Al Gore, Chairman of Generation Investment Management, and Former Vice President of the United States, with his call for responsible, sustainable capitalism. This he describes as a framework that seeks to maximize long-term economic value by reforming markets to address real needs while integrating environmental, social and governance (ESG) metrics throughout the decision-making process.
Gore also points out that around $30 trillion of assets are currently signed up to the UN Principles for Responsible Investment - some 20% of the world's capital - and says: "If the majority of those assets were actually shifted into truly sustainable investment models, the effect would be dramatic and would signal that Sustainable Capitalism is entering the mainstream."
And there are real signs that investor behaviours are changing, albeit slowly, in response to the challenges they face, but also motivated through enlightened self-interest - the need to protect the value of their assets.
In 2011 nearly thirty Investor organisations, representing over $170 billion of assets, urged the US Environmental Protection Agency to initiate a review process to evaluate the mine waste impacts of a proposed mine on Alaska's Bristol Bay watershed, which produces roughly half the world's commercial supply of wild sockeye salmon.
The group of investors, led by Trillium Asset Management Corp and Calvert Investments, collectively holds over 13 million shares in Anglo American plc, the UK-based mining company. They recognised the combined impact and risks associated with the proposed mine could have a devastating impact on the natural habitat and local economy.
They also recognised the potential for significant environmental costs, taking heed of the UNEP FI Universal Ownership Report, and the consequential risk to company earnings and therefore investor returns. They calculated that 50% of company earnings could be at risk if this project were to proceed. Taking a far-reaching view, they could also see that any problems with this project could cast a shadow over all mining projects, even responsible and safe ones, which could destabilise the global mining industry. This led to the investors issuing a formal statement to call for a review process as a responsible and crucial step.
Microsoft provides a further example of a company responding positively to activist shareholder pressure. The New York City Pension Fund, an institutional investor, was keen to make sure its investments were protected from any adverse affects on company revenue that could be brought on by labour, environmental or other issues involving Microsoft. As a result, Microsoft will now make supplier sustainability disclosure mandatory from 2013.
Just like business leaders, the workforce and the wider population, investors are going through their own transformation, as they too try and make sense of the post-crisis world, and move stutteringly towards a sustainable, low carbon economy. There is still some way to go, before quantification of sustainability principles, risks and opportunities becomes a mainstream consideration for investors. But, given the very real impact of key issues like climate change, energy and resource scarcity, along with increasing regulation and reputational risks, it is only a matter of time before we see a clear and direct relationship between sustainability impact, business performance and stock price.
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This blog is based on an article originally published by the author in Sustainable Business magazine.