Better returns from better-run companies

For investors, it seems that old habits die hard.

A recent report from the Morgan Stanley Institute for Sustainable Investing, found that more than half of investors – 54% – believe that sustainable investing involves a financial trade-off: that it provides the feel-good factor but only in exchange for lower returns.

This attitude persists in the face of numerous other studies showing that sustainable investing produces better, or at least no worse, returns than more traditional investment strategies. A quick look at the S&P US Carbon Efficient Index shows that it outperforms the S&P 500 benchmark index of top US companies.

Morgan Stanley itself has found that sustainable investing has advantages over investment strategies that do not take sustainability into account. A separate Morgan Stanley report found that, in general, mutual funds that invest in more sustainable companies perform as well or better than traditional investment funds.

Good management

And in case any more evidence was needed, researchers from Oxford University published a major study in late 2014 that analysed about 200 studies, finding that 80% of them “demonstrate that prudent sustainability practices have a positive influence on investment performance”.

This should not be a surprise. A focus on sustainability is a proxy for good company management. More sustainable companies concentrate on areas such as energy and resource efficiency, which translate into lower costs.

They also improve their performance through environmental, social and governance policies and practices, and anticipate the increasing tide of sustainability-related regulation, by, for example, voluntarily setting greenhouse gas reduction targets.
 
What investors want

With such evidence, it is perhaps surprising that more investors have not been demanding a greater focus on sustainability from the companies in their portfolios.

Things are changing perhaps – an increasing switch to sustainability by investors might be underway. Investment managers LGT Capital Partners and consultants Mercer found in another recent survey that 54% of institutional investors who incorporate ESG criteria in their decisions have done so only for the last three years or less.

The investors that continue to believe sustainable investing involves a financial trade-off are perhaps influenced by some shortcomings in company reporting that sustainable investors themselves regularly highlight.

In particular, companies stand accused of still not properly linking what they say on sustainability to business strategy and risk. Many companies have yet to get to grips with the issue of materiality and demonstrate what sustainability really means for their operations.
 
The right reporting

Investors also complain that companies’ non-financial reporting is hard to compare, or that information is simply lacking, especially in terms of key performance indicators.

For example, a Corporate Knights Measuring Sustainability Disclosure report, published in October 2014, found that only 2.8% of large listed companies worldwide disclose all of what it called the “seven basic sustainability metrics”: employee turnover, energy, greenhouse gas emissions, injury rate, payroll, waste and water.

So while it is time for investors to dispense with old prejudices about financial trade-offs and sustainable investing, there is also a need for companies to more convincingly make the case, and to help investors by improving their reporting and providing clear, relevant disclosures.