ESG Links: Allocating with Purpose

Due to client demand, Ritholtz Wealth Management has created an ESG version of our classic asset allocation models, known as the Portland Portfolio. Research shows that high net worth families are increasingly interested in directing their investable assets toward companies with good records on Environmental, Social and Governance issues.

Please enjoy the below reads, curated by our in-house ESG expert, Joey Fishman. And if ESG investing is something you’d like to learn more about, talk to us here. 

 

The Comprehensive Business Case for Sustainability (HBR)

McKinsey reports that the value at stake from sustainability concerns can be as a high as 70% of earnings before interest, taxes, depreciation, and amortization.

72% of corporations said that climate change presents risks that could significantly impact their operations, revenue, or expenditure

Many business leaders have the erroneous perception that one can have profits or sustainability, but not both. That conventional wisdom has now reversed.

Significant cost reductions can result from improving operational efficiency through better management of natural resources like water and energy, as well as minimizing waste. One study estimated that companies experience an average internal rate of return of 27% to 80% on their low carbon investments.

Mounting evidence shows that sustainable companies deliver significant positive financial performance, and investors are beginning to value them more highly. Arabesque and University of Oxford reviewed the academic literature on sustainability and corporate performance and found that 90% of 200 studies analyzed conclude that good ESG standards lower the cost of capital; 88% show that good ESG practices result in better operational performance; and 80% show that stock price performance is positively correlated with good sustainability practices.

Here are some other datapoints to consider: Between 2006 and 2010, the top 100 sustainable global companies experienced significantly higher mean sales growth, return on assets, profit before taxation, and cash flows from operations in some sectors compared to control companies. During the 2008 recession, companies committed to sustainability practices achieved “above average” performance in the financial markets during the 2008 recession, translating into an average of $650 million in incremental market capitalization per company. Additionally, companies with superior environmental performance experienced lower cost of debt by 40-45 basis points. Studies also suggest that companies with strong corporate responsibility reputations “experience no meaningful declines in share price compared to their industry peers during crises” versus firms with poor CSR reputations whose reputations declined by “2.4-3%; a market capitalization loss of $378M per firm.”

Nearly two-thirds of consumers across six international markets believe they “have a responsibility to purchase products that are good for the environment and society” — 82% in emerging markets and 42% in developed markets.

Companies can also charge higher price premiums based on positive corporate responsibility performance. These premiums can reach 20% according to some estimates. Moreover, some studies show that overall sales revenue can increase up to 20% due to corporate responsibility practices.

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Millennials are coming and they want Sustainable Investments (Bloomberg)

84 percent of millennials were interested in sustainable investing. “Really significantly, they’re also twice as likely to invest in a stock or a fund if sustainability is part of the value-creation thesis,”

One of the few remaining barriers to the adoption of sustainable strategies is the perception that they’re not profitable, Choi says—an idea that’s increasingly being proved wrong: “There’s more and more recognition that thinking about sustainability is entirely consistent with a fundamental understanding of financial risk and reward.”

The relative performance of sustainable strategies is important… If you plot the returns of the traditional strategies, you get a normal distribution—some performed very well, some poorly, and most were in the middle. The result when you plotted the sustainable strategies? The same.

When it comes to data and measurement of ESG metrics, the investment industry is currently in a “creative abundance phase……but……not every metric is relevant to every industry.

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Moody’s Issues First Green Bond Assessment in US (The Bond Buyer) 

The Upper Mohawk Valley Regional Water Finance Authority received a green bond assessment of GB1 for $8.78 million of water system revenue bonds on Wednesday from Moody’s Investors Service — the first GBA the rating agency has issued in the U.S.

The GBA, which ranges from GB1 for excellent to GB5 for poor, is designed to help investors determine if green bond proceeds are being used to achieve “positive environmental outcomes,”

Moody’s rolled out the final methodology for the GBA, which is not a rating, at the end of March.

Moody’s said global green bond issuance during the second quarter reached a new quarterly high of $20.3 billion, raising total volume for the first half of the year to $37.2 billion, an 89% increase over the same period a year ago.

The U.S. accounted for about 22.8% of the second quarter issuance and 19.8% of first quarter issuance, Moody’s said. U.S. Issuers in the second quarter were from Massachusetts, New York, California, Maryland, Indiana, Cleveland, Ohio, New Jersey, Rhode Island, and St. Paul, Minn.

The GBA is determined according to five key factors: organization; use of proceeds; disclosure of the use of proceeds; management of proceeds; and ongoing reporting and disclosure on environmental projects financed or refinanced with the bonds.

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Corporate Investment in ESG Practices (Harvard Law)

The question arises as to whether this type of resource allocation should be made even when it does not respond to an immediate business concern, based on the consideration that the ESG practice in question will serve the corporation as an intangible asset, reinforcing the trust of stakeholders in the business, and ultimately generating a return in terms of better firm performance. For example, should a company introduce more stringent procurement standards that would require it to sever its ties with a cost-efficient supplier, in the absence of a specific reputational incident or an explicit stakeholder demand? Similarly, should a company (continue to) invest in its employee engagement program in the absence of any indication of employee dissatisfaction? Should a board of directors adopt a diversity policy that could require one or more of its well-performing current members to step down?

A review of empirical research regarding the return on investment in ESG initiatives identifies five pillars of the business case for corporate sustainability:

1. Corporate investment in ESG enhances market and accounting performance
2. Corporate investment in ESG lowers the cost of capital
3. Corporate investment in ESG is a means of engagement with key shareholders
4. Corporate investment in ESG improves business reputation
5. Corporate investment in ESG channeled to product innovation fosters new revenue growth

The return on ESG investment has been widely investigated in the last decade. Even though there is great variation in the methodologies deployed, the data sources used, and the time horizon examined, many research projects have explored the link between this type of resource allocation and key measures of firm performance.

Considering these studies as a single body of work can lead to major simplifications. In particular, it runs the risk of overemphasizing the conclusions about a phenomenon that remains difficult to analyze empirically, primarily due to the lack of a universally adopted framework to capture and disclose ESG practices. Other research organizations have conducted meta-studies to categorize these empirical analyses, calculating the percentage of them that prove a link between ESG investment and certain metrics of performance. It should be noted, however, that such a meta-analytical approach does have its shortcomings, as it puts the studies on a par with one another, without fully validating individual methodologies and data sources. It also ignores a publication bias, given that studies that show a negative or insignificant correlation are less likely to be published.

Corporations have been investing in ESG practices more frequently in the last decade. However, these resource allocations often respond to immediate business needs rather than a strategic and cohesive sustainability program intended to enhance for the long-term key intangible assets in the environmental, social, and governance spheres.

While empirical research on the link between corporate investment in ESG and firm performance is far from undisputed, several studies led by respected institutions have shown that a company can be rewarded for adopting these practices: higher profits and stock return, a lower cost of capital, and better corporate reputation scores are the key benefits enjoyed in return for this type of investment. As companies continue to adhere to harmonized reporting standards and verified data becomes more readily accessible, researchers will be able to continue this course of investigation and find the definitive proof that ESG-related corporate expenditures do pay off.

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ESG DEFINITIONS / TYPES

Examples of ESG incorporation strategies can be summarized as follows:

Positive/best-in-class: Investment in sectors, companies or projects selected for positive ESG performance relative to industry peers. This also includes avoiding companies that do not meet certain ESG performance thresholds.

Negative/exclusionary screening: The exclusion from a fund or plan of certain sectors or companies involved in activities deemed unacceptable or controversial.

ESG integration: The systematic and explicit inclusion by investment managers of ESG factors into traditional financial analysis.

Impact investing: Targeted investments, typically made in private markets, aimed at solving social or environmental problems.

Sustainability themed investing: The selection of assets specifically related to sustainability in single- or multi-themed funds.

Click here for more….http://www.ussif.org/esg