ESG investing: What IT leaders need to know
Not so long ago, a prevailing view in finance was that healthy returns are inconsistent with a “responsible” investing strategy. Financial professionals believed that shrinking one’s universe of investable stocks by factoring in environmental impacts, social influences, or governance factors—now collectively called ESG investing—would make outperforming the market more difficult.
No longer. Today, investors realize that sustainable investing is going mainstream and that it can provide similar or sometimes better returns than traditional investments. Some $23 trillion in assets globally are now invested according to ESG principles. Most of those assets are in Europe, but sustainable investing is also growing in the United States. Several studies now refute the once-accepted view that investing with ESG principles negatively impacts returns. One study by Harvard Business School professor George Serafeim found that, over the long term, improving environmental or social performance can have a positive impact on financial performance and shareholder returns. Another study, by Barclays, found a “small but steady” performance advantage by introducing ESG factors into the investment process.
Why IT should pay attention to ESG
As ESG criteria become more important to investors, the IT sector should pay particular attention. Issues such as energy use, labor practices, the environmental impact of manufacturing processes, and privacy and cybersecurity, among others, are high on the agendas of institutional investors looking for ESG risks within investment portfolios. Conversely, IT can play a positive role in ESG because it allows for social enablement through greater access to information, finance, or healthcare in previously remote and underserved regions of the planet. And the smart use of technology and innovation will undoubtedly be key to solving our biggest environmental problems.
There’s another reason we should take ESG seriously: Technology is playing an ever-widening role in the global economy. IT spending is exploding, fueled by declining prices and rapid innovation in the sector. IT spending has risen faster than GDP for many years, and IDC predicts that by the end of 2019, spending on IT for digital transformation projects will reach $1.7 trillion worldwide, an increase of 42 percent from 2017. Digital transformation is rapidly reimagining industries such as healthcare, financial services, and retail. And while new technologies such as machine learning and artificial intelligence will allow companies to make positive contributions to ESG—improving energy systems and reducing emissions more effectively, for example—they also present ESG-related risks, such as automated biases unintentionally built into AI algorithms.
Sustainable investing is not new, of course. In the past, it usually meant avoiding investments in companies or industries because of their moral values—those engaged in gambling or sales of tobacco, for example—an approach called socially responsible investing (SRI). Similarly, in the 1960s, the Vietnam War led some investors to drop arms-related investments, and in the 1980s, we saw funds begin to shun investments in apartheid-era South Africa. The idea was to reduce exposure to negative externalities.
Today, sustainable investing has evolved beyond simply excluding companies. Ethical considerations remain, but investors are now looking at ESG factors alongside traditional financial analysis as a way to deepen their understanding of risk factors within a company. Also at work are changing social norms and demographics, particularly among millennial investors, who regularly express a desire for sustainable investing solutions.
Take, for example, Equifax’s 2017 data security breach. Investment index company MSCI gave Equifax its lowest ESG rating in August 2016, warning investors about the company's poor data security and privacy measures. Then, in September 2017, Equifax confirmed it was a victim of a cyberattack, potentially compromising the sensitive data of millions of U.S. consumers. The company’s stock price fell just over 30 percent in the days following its revelation, but investors could have avoided the loss by following MSCI’s warning. Clearly, ESG-related issues are integral to fiduciary responsibility, and they offer another data point for investors looking to better understand risk in the companies they may wish to add to their portfolios.
Demographics is another primary driver of ESG investing. A growing body of research suggests that millennials as well as women as a group are asking more of their investments, looking for ways to ensure that their portfolios match their values. Over the next two to three decades, the millennial generation could put between $15 trillion and $20 trillion into U.S.-domiciled ESG investments, which would roughly double the size of the U.S. equity market.
And while five years ago, only about a quarter of public companies produced a sustainability report each year, today that number is higher than 80 percent. We are now reaching a point where company boards are pushing for ESG accountability, concerned about the potential impact on their company’s stock price.
Another factor driving the growth of ESG investing is the improved data from companies combined with better ESG research and analytics capabilities. This is leading to more systematic, quantitative, objective, and financially relevant approaches to key ESG issues. While we still need more standardization around how companies measure, report, and define ESG data, increasing levels of data and analytics have paved the way for numerous studies that explore ESG investing. And many large credit agencies, such as Moody’s and S&P Global, now incorporate ESG data into their credit rankings. Major investment service agencies such as Bloomberg now incorporate ESG data into the information provided to investment analysts, and investors overall are paying attention to key rankings such as the Dow Jones Sustainability Index. DJSI is a global index of sustainability and one where, I’m proud to say, Hewlett Packard Enterprise has consistently achieved a very high score.
As investors focus on finding new companies with strong sustainability practices, they are effectively encouraging companies to improve their ESG scores. Greater investment in ESG-focused companies may therefore lead to better corporate governance, meaning the benefits of a sustainable investment portfolio could be self-perpetuating.
During the 2018 proxy season, environmental and social concerns accounted for more than half of the shareholder proposal submissions, according to ISS Analytics, the data intelligence arm of Institutional Shareholder Services, a proxy advisory organization. The growth builds on momentum seen in 2017, when climate-risk proposals at energy-sector giants such as Exxon Mobil won majority votes. The resolutions require enhanced annual disclosure of the business impact of climate change.
Some leading Wall Street investors are applying pressure, too. In January, BlackRock CEO Larry Fink posted a 2018 letter to CEOs, putting them on notice that the world’s largest asset manager, which at the end of December had $6.29 trillion in assets under management, will no longer support companies that do not make positive contributions to society, linking ESG to long-term value creation.
Fink’s letter was a huge step forward for ESG investing in the United States and signaled that asset managers no longer consider ESG a niche investment strategy. Indeed, an Ernst & Young survey of institutional investors in 2016 found that more than 75 percent of investors would reconsider or rule out an investment decision based on such issues as unmanaged ESG risks in the supply chain or risk from climate change.
Investors such as Fink and Berkshire Hathaway's Warren Buffett have long advocated for a long-term approach to investing. Employee turnover, loyal customers, and responsible environmental practices may not lift next quarter’s results, but they may produce solid long-term results.
Boosting your ROI
Action at the company level is of course key. Take, for example, UPS. The logistics giant has developed a fleet management system called On-Road Integrated Optimization and Navigation (ORION), which it sees as a competitive differentiator in its business sector. ORION uses big data to create optimal routes for delivery drivers, thereby saving miles driven, fuel, and costs. Since deploying ORION in 2013, UPS has avoided driving 210 million miles, saved 10 million gallons of fuel, and reduced CO2 emissions by 210,000 metric tons. Going forward, UPS expects to see annual reductions of 100 million miles and 100,000 metric tons in CO2 emissions.
ESG also appears to be pushing companies like UPS to improve operating efficiency by bringing to market innovative products with positive ESG profiles. According to the “Project ROI” study, sponsored by Campbell Soup and Verizon, adherence to ESG principles can help increase sales revenue as much as 20 percent and affect variations in customer satisfaction by 10 percent or more. It can also reduce the company’s staff turnover rate by as much as 50 percent. Separately, interviews with 210 U.S.-based finance executives, conducted by ING, found that 43 percent believe revenue growth is a key driver for their actions on sustainability, while 87 percent have experienced some level of revenue growth over the past 12 months due to sustainability practices.
Identifying ESG risks
As sustainability rises to board-level agendas, company leaders are no doubt asking how they can disclose their climate risk profile and integrate it into their financial filings. With this question in mind, the Financial Stability Board formed the Task Force on Climate-Related Financial Disclosures (TCFD) in 2015. The group has since produced a set of recommendations to support more accurate asset valuation, capital allocation, and risk management when it comes to climate-related issues. The recommendations are designed to help companies identify and disclose the possible financial impact of ESG-related risks, which should help investors better evaluate and price those risks.
However, while there is growing support for the recommendations, questions about how companies can turn them into actionable strategies are growing. Research by CDP and Marsh & McLennan Companies’ Global Risk Center shows there are three main areas where companies are having difficulties: ensuring the support of leadership, overhauling risk assessment processes, and using scenario analysis to understand the strategic implications of climate-related risks and opportunities.
All three areas are important, of course, but perhaps the most vital is ensuring the support of senior leadership. As the CDP research notes, boards of directors do discuss environmental issues, but “few are turning their awareness into action.” With climate change posing serious threats to communities and companies, we need to move beyond talking and begin acting, recognizing that battling climate change can bring new opportunities for economic growth.
For investors, we must continue to make the case that there is a positive correlation between stronger ESG performance and increased returns on investment. Even if some investors aren’t convinced by the data from such organizations as Calvert, Morningstar, and Morgan Stanley, and believe no such correlation exists, they would surely still want to invest in companies that care about societal and environmental issues—especially if doing so does no harm to their investment returns.
ESG investing and why IT should care: Lessons for leaders
- Environmental, social, and governance criteria are becoming more important to investors.
- Issues such as energy use, labor practices, the environmental impact of manufacturing processes, and privacy and cybersecurity, among others, are high on the agendas of institutional investors looking for ESG risks within investment portfolios.
- IT can play a positive role in ESG. It allows for social enablement through greater access to information, finance, or healthcare in previously remote and underserved regions of the planet.
- The smart use of technology and innovation is key to solving the biggest environmental problems.
This article/content was written by the individual writer identified and does not necessarily reflect the view of Hewlett Packard Enterprise Company.