January 17, 2018

What does ESG data actually tell us about listed companies?

by Thomson Reuters.

Environmental, social and governance (ESG) data is increasingly influencing how investors look at investee companies. As Detlef Glow, Lipper’s head of EMEA research, wrote in a recent blog, though the majority of investors do not invest in sustainable products, there is an increased interest in the practice as many begin to understand the importance of nonfinancial risks to a company’s long-term health.

Some institutions are leading the way here, too, like Hermes, the UK-based fund manager, which actively stewards its managed and advised assets to ensure it fulfils its fiduciary duty.

The institution’s head of sustainable investing, Andrew Parry, is a believer in the holistic nature of an ESG investing strategy. Speaking on a panel at the 12th annual Lipper Alpha Expert Forum, he said that companies that were efficient with their use of resources – whether environmental, social or internal – demonstrate that they are serious about maintaining their long-term health.

“[ESG] is not just an isolated set of activities you do…when you’re going to be environmentally and socially conscious”, he said. “We know that [ignoring it] damages your wealth. It should just be integrated increasingly into the way that you think.”

In other words, ESG investing does not represent an investor taking a purely ethical stance, best reflected by other decisions such as divesting from the tobacco industry, for example, but rather a financially-motivated decision in search of long-term returns.

Parry and his co-panelists identified another problem for investors new to ESG issues: there is no standard set of metrics by which to judge companies. While some institutions will look at carbon emissions, others will prioritize water usage or clean energy consumption – and knowing which will have the greatest impact on a company’s valuation or long-term success can be hard to predict.

Thomson Reuters’ recent research into the relationship between decarbonization strategies and long-term financial performance seeks to answer this question. It produced a report which examined a group of 250 companies who represented a third of global annual emissions in order to assess efforts among them to address climate change.

The research – available in full here –  found that when comparing multiyear decarbonization trends and a broad set of financial metrics, there is no evidence of a trade-off between financial and environmental performance. Of the 250 companies examined – dubbed the G250 – 20% have strategies in place to tackle their climate impacts; of these, a significant number have demonstrated that “transformation strategies create real business value through cost structure improvements and new revenue growth opportunities, as well as risk mitigation.”

The report makes the point that these strategies can take at least a decade to provide business results, and examines the successes of a few G250 members. US utilities firm Xcel Energy, for example, has transformed the core of its business since 2004 to reduce greenhouse gas emissions, promote solar energy among its customers and updating its business strategies. In the same period, it outperformed the rest of the US energy market significantly.

Other companies, such as Ingersoll Rand, an industrial equipment manufacturer, have matched these results through setting and meeting sustainability goals, carving out a competitive advantage versus their peers to outperform the S&P 500 over the past five years by 132%.

Though the research recognizes that other factors can of course affect the financial performance of a company, modeling the most serious carbon emitters’ performance against their ESG activities does show a strong correlation, and there is no doubt that making a low-carbon transition can help firms build competitive advantages.

Truly understanding these metrics, and developing a more comprehensive framework for assessing the financial worth of decarbonization, is a short way away. More efforts like these can help answer the question of what ESG tells an observer about the long-term financial health of a company.

Do you have an ESG mandate? Find out more about Thomson Reuters ESG data.

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