- The theme of this year’s Sustainable Investing Seminar is “Moving into the Mainstream.” What does that mean to you?
Using material environmental, social, and governance (ESG) issues as a potential outperformance driver is becoming more common across asset managers, asset owners and asset classes, although those doing so are still in the distinct minority. Investors are beginning to closely examine “what is sustainable investing” and moving beyond Socially Responsible Investing which is effectively negative screening. As Sustainable Investing, defined as generating consistent returns on a long-term basis, increasingly moves into the mainstream, it will continue to expand globally. I’d even venture to say that within six months, nearly every asset owner and asset manager will claim to have one or more ESG products.
- Why is it important for financial professionals to increase their knowledge about Sustainable Investing?
There is a problem with the term “sustainability” and it’s really more effective to think in terms of the concept of materiality. Evidence from various studies shows that ESG integration makes a difference in performance and investors need to pay attention to companies whose ESG actions will affect investment performance in the long-term, both from an upside and downside perspective. To quote Mozaffar Khan, George Serafeim, and Aaron Yoon, “…firms with high materiality scores and concurrently low immateriality scores have the best future stock performance…” (Harvard Business School Working Paper 15-073, Corporate Sustainability: First Evidence on Materiality). What’s interesting is that today many financial professionals don’t even consider ESG factors because they’re not sure whether they are material or not. Furthermore, they’re looking to companies to tell them if their ESG issues are material, not third parties.
Materiality forms the conceptual bedrock of corporate reporting, yet no authoritative definition of it exists. In order to measure this ESG-driven performance, standards are going to be critical and, fortunately, the Sustainability Accounting Standards Board (SASB) is creating those standards at the industry level through a classification system that has 80 industries. In fact, one of the highlights of BSAS’s 2015 Sustainability Investing Seminar, in my opinion, is that SASB’s CEO, Jean Rogers, PhD PE, will discuss the work of SASB.
- Why do you think clients are increasingly interested in sustainable investing products?
There’s no simple answer. However it is clear that investors are not just focusing on return on investment, they’re also focusing how on the return of their investment is being earned. It’s also true that there is a market for sustainable investing products because it is a politically correct trend. With this trend comes a feeling of responsibility – retail clients still want good returns, but now they care more about how it gets done. Because of this increased interest, investors will look at companies through more of an ESG lens. Increasingly, we’ll find that portfolio companies who say clearly what financial and nonfinancial audiences are significant, and report on these audiences material issues – will achieve superior performance.
We also see this in Family Offices where financial professionals are beginning to deal with a new generation that is more values-based. Now, when having family assessment discussions, it’s important to consider:
- Who are the material or significant nonfinancial audiences for the firm, looking forward?
- What are the material or significant nonfinancial issues for the firm, looking forward?
- How can we best assess the governance of the firm, based on the above answers?
Finally, we’re seeing evidence that demonstrate the importance of looking at credit and credit ratings. Best-in-class Fixed Income asset managers almost always take credit ratings and then re-rate them to include an ESG measurement for long horizon clients like Family Offices.
- What “tools of the profession” might seminar participants walk away with?
I’ll finish the seminar with a wrap-up of the day, and I’m looking forward to participating in all the sessions, listening to the presenters, noting the feedback, and including the highlights in my wrap-up. As I mentioned before, I already know that Jean Rogers’ session will be fundamentally important to showing how sustainability standards are moving into mainstream investing. As SASB establishes the key performance indicators (KPIs) for reporting on their standards analysts will be able to more effectively compare industry-wide sustainability performance on an apples-to-apples basis. These standards will enable a wide range of Big Data analytical tools to be developed for investors—as well as companies. Once we have more data and standards on material issues, then tools will begin to develop organically.
- Where do you see ESG and sustainable investing going over the next five years?
One principle of good corporate governance will be that the board of directors issue an annual “Statement of Significant Audiences and Materiality.” In this Statement the board need to determine a limited number of significant audiences – above and beyond shareholders – in order to more clearly define which issues are “material” to the ability of the corporation to sustain itself over a self-defined period of time. Materiality’s guiding principle is conciseness. Boards that have the courage to be concise and limit reporting to only material information will also send the meta-message that they have the ability to exercise judgment – in other words, to govern.
Evaluating material ESG issues creates value for shareholders and for the corporation itself (separate from shareholders) in the long term which, in turn, contributes to a more sustainable society. Within the next five years, investors will have a better window into the governance structures of companies they target for investments. As the practice of the board of directors issuing The Statement continues to evolve, there will be increasing evidence demonstrating the consequences of good or bad governance.
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