rethink sustainability
Funding for the future - why investing sustainably is good business
These are very different times in how companies do business. Shareholders are in a better position than ever to affect change and to help plot a course to sustainability.
A new range of considerations are now in play - how the climate is changing, where raw materials can be found and increasingly unpredictable political systems. And at the same time, the internet has brought the demands for fresh transparencies.
This combination has meant that there is much greater interest in what companies do, what happens in their supply chains and where their raw materials come from. Thanks to the internet, people are better-informed than in the past, and due to social media, they can share that information quickly and widely. Companies are now acutely aware that their business practices are under intense scrutiny from both shareholders and a wider audience.
Investors determined to avoid companies perceived to engage in unethical business practices have a greater range of tools at their disposal. Global divestment campaigners such as 350.org and Global Divestment Mobilisation have persuaded over 800 institutions and almost 60,000 individuals to pull their investments from the fossil fuel sector. Although some companies in the area are taking on more sustainable practices, long-term issues remain. Protestors make their point in other ways as well - Greenpeace activists abseiled into Total's (which itself scores highly on ESG standards) annual meeting to protest about the firm's plans to drill in French Guyana, while Amazon's attracted everyone from pilots angry at staffing levels at Amazon Air to workers demanding that the company stop selling facial recognition software to police departments.
Investors have for decades excluded certain sectors, such as weapons, alcohol and gambling, from their portfolios for ethical or religious reasons, but many investors still believe that taking into account environmental, social and governance (ESG) issues will lower returns, even though there is growing evidence that the opposite is true, which is spurring greater demand for change.
The pressure to transition to a more sustainable model is having an impact. Norway's state pension fund, the world's largest, recently proposed selling off the $35 billion oil and gas stocks that it holds, and the Church of England has also recently voted to withdraw its funds from fossil fuel companies. Meanwhile, Ireland has recently introduced a bill to divest all the country's investments in fossil fuels, following a host of other high-profile investors including both the city and the state of New York.
Some commentators argue that despite the high profile of some of these investors, the impact on companies is minimal. They say divestment achieves little because sellers are simply replaced by others less concerned by ethical issues and engagement with companies in which shares are owned is better than losing influence by selling.
But divestment does a couple of things. Firstly, it sends a strong message that many shareholders are no longer prepared to tolerate a particular behaviour, increasing pressure on companies to change their activities and business strategies. Secondly, it affects sentiment on the company and sector, particularly as many of the funds divesting are investing for the longer term and so have strong economic reasons for doing so, within that time frame.
And while there is still a strong narrative that restricting your options will hurt returns, there is a growing body of evidence that this is not true. MSCI said that its All-World index, including ESG factors, outperformed its parent index, that excluded ESG, by 39 basis points every year over five years.
There are signs that views on the financial implications of divestment are changing. Many of the investors selling out of fossil fuels are pension funds, such as the New York State Common Retirement Fund, that have a fiduciary duty to do the best for their beneficiaries. They are not leaving the sector for ethical reasons but for financial ones – they believe that holding these stocks will hurt their returns over time.
There are signs that views on the financial implications of divestment are changing. Many of the investors selling out of fossil fuels are pension funds…that have a fiduciary duty to do the best for their beneficiaries. They are not leaving the sector for ethical reasons but for financial ones – they believe that holding these stocks will hurt their returns over time.
But divestment is not the only option. It is one thing to affect change from the outside looking in but it cannot rival stewardship in terms of effectiveness.
Certainly shareholders are recognised as the link to real change. Engaged consumers and NGOs are targeting shareholders to sell their shares in companies seen as unethical as never before, particularly in the field of climate change, but also in a range of other issues from gun control to gay rights. US investors filed 66 shareholder resolutions related to climate change in 2018's annual meetings season and companies including ExxonMobil, Shell and BP have agreed to produce reports on how climate change will affect their business.
With the growth of passive investing, more and more institutions are invested across the entire economy and are not in a position to sell out of individual stocks, while others simply believe that they can better improve the performance of the companies they are invested in by engaging with them rather than selling their shares. Indeed some investors specifically buy shares in companies so that they can engage with them. A group of US churches bought shares in gun manufacturers so they could ask them to tackle gun safety.
It also increases the impact of those investors who do engage with companies, showing management that shareholders' concerns are not isolated and need to be taken seriously. Carbon Tracker, a think tank focused on the business risks of investing in fossil fuels companies, has said that divestment creates a pressure which is needed. "Engagement without divestment is like a criminal legal system without a police force," it said.
According to the UN Principles for Responsible Investment (PRI), “there is clear evidence that engagement by investors with companies on ESG issues can create shareholder value".
One area where engagement has a clear advantage is in encouraging companies to capture the opportunities created by today's sustainability challenges, as well as considering the risks. With the United Nations' Sustainable Development Goals and the Paris Agreement on climate change driving the future direction of policy and regulation, companies that want to continue to thrive need to take sustainability imperatives into account – and investors can help them to do so.
A growing number of investors are seeking out companies that are well positioned to benefit from the Sustainability Revolution, because those are the ones that are likely to generate substantial excess returns in future. At the same time, they want to avoid investing in businesses that cannot or will not change their business models, because of the risk that these business models may become 'stranded' due to changes in regulation or consumer sentiment.
A growing number of investors are seeking out companies that are well positioned to benefit from the Sustainability Revolution, because those are the ones that are likely to generate substantial excess returns in future.
Sustainability is set to be one of the most important drivers of the global economy in years to come, an issue that will affect everyone. Companies need to have strategies in place to take advantage of the opportunities sustainability issues will create and to be able to deal with the risks that will also come. Investors can help them to move in the right direction by engaging with management to encourage positive changes; if all else fails, they may need to consider selling their shares.
Important information
This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.
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