Nowadays, sustainability in a business environment has become one of the most important keywords. The sustainability of a company, its environmental friendliness, effective management principles, whether the company takes care of its employees, assesses potential long-term risks together with their solutions, may affect its ability to attract investment and financing. It is sustainability that today becomes one of the key criteria for investors that make their decisions based not only on the rate or risk of a potential return on investment; they specifically consider the environmental or social impact of their investment. But how do you verify whether the values declared by companies are not just a beautiful facade?
ESG can help to separate the wheat from the chaff
Most businesses today declare their social responsibility, representing themselves as “green-minded” and smart. This is only natural, as the issues are increasing of concern to society and consumers, and businesses are rapidly becoming an integral part of the social system. Still, it is one thing to talk about it, but in reality, to manage operations while respecting the principles, to introduce advanced processes, to increase resource efficiency and to reduce environmental impacts, while at the same time respecting social aspects, is quite a different matter. Therefore the ESG (environment, social and governance) factors are increasingly used to assess long-term corporate sustainability. In simple terms, ESG companies are advanced companies that assess their potential impact on the environment, take care of the environment and pollution, value their employees and customers and apply the highest management standards. Such companies consider all possible long-term risks and ways to mitigate them, and next to the vital financial ratios they monitor the relevant ESG factors.
It is our job to analyse dozens and hundreds of companies around the world, not only from the financial viewpoint, but also in terms of ESG. This requires looking into a range of topics that can affect the sustainable functioning of businesses, ranging from climate change to gender equality and the impact of “tax havens”.
It is essential to realise that an ESG assessment does not merely simply attach labels to companies in advance and declare them as good or bad. Oil or energy companies can also take care of their sustainability, and a technology start-up is not necessarily automatically the definition of sustainability. In addition, even the least sustainable companies can change for the better. An important task for each company is to identify its most significant potential long-term risks and the ways to mitigate or tackle them. Assessing the sustainability of enterprises in line with ESG factors requires a comprehensive case-by-case assessment and analysis of the situation.
“Green” image does not suffice
To attain long-term sustainability, it is not enough to install solar power panels on the office roof, to claim that the produced products are environmentally friendly, or to contribute to ongoing social promotions. The context and the actual impact of an undertaking's activities on relevant areas are always important to factor in when conducting an ESG assessment. For example, a company publicly states that its product is environmentally friendly, emitting significantly less CO2 than others, but ultimately it turns out to be a lie and customers along with the rest of society, are left grossly misled. Along with the lies, the internal governance weaknesses are revealed, which compromises confidence, not only in trust in the company itself, but also in the sector, or even the very idea of sustainability. Rather, the whole image becomes merely a manifestation of greenwashing.
At the same time, an enterprise that does not pay much attention to its sustainability image, but rather acts solely as a logical business decision-maker, ensuring efficient operating processes, deploying modern technologies and management principles, investing in employees and maintaining constructive relationships with communities, can be rated according to ESG criteria extremely well. Thus, a genuine path towards sustainability requires much more than demo projects or virtuous declarations.
Of course, various companies may place a focus on different aspects of sustainability; therefore, it is the objective of ESG analysts to assess how much effort the company is making to actually be sustainable, and where through public relations and marketing, it simply seeks to take advantage of the growing public awareness.
Investments can be made in a sustainable and profitable way
As regards the return on investment in ESG companies, it is not really that straightforward in this case. Investment choices are still often presented through a dilemma – higher financial returns as opposed to sustainability. It is as if these things are incompatible and an investment portfolio composed of ESG corporates would only yield lower returns. Still, nowadays this is certainly not necessarily true.
Long-term academic studies show that in 90% of cases, investing according to ESG criteria does not adversely affect investment portfolio earnings. In other words, the ESG filter does not sacrifice the financial return for the sake of sustainability.
The study conducted by our team also showed that over the past 10 years, the return on the ESG investment index exceeded the stock market averages – although this difference was not very prominent, reaching about 16 per cent. Besides, it could have been caused by some other factors apart from the growing interest in ESG, such as the growth of the technology sector that constitutes one of the most tangible shares in ESG funds, or the energy sector that survived the best times on stock exchanges due to falling oil prices, but from the ESG perspective, is currently one of the least invested sectors.
The future belongs to the sustainability
Companies following ESG ideas are currently highly popular among investors and this trend can be expected to continue. According to an investor survey conducted in the US, modern investors, and especially their younger generation, are determined to contribute to societal global environmental or social goals such as mitigating climate change or reducing poverty when making investment decisions. This can have a really significant impact on stock markets - especially given that over the next several decades the younger generation of investors are estimated to inherit or take over nearly $30 trillion worth of assets from their parents
The limited supply of shares in ESG companies and the significant increase in demand from young investors could adequately inflate the equity of sustainable companies. In any case, the changing generation of investors and public attitudes are likely to determine the demand for and attractiveness of ESG investments in financial markets for a long time to come. As a result, companies currently neglecting the sustainability aspect risk losing their ability to attract finance and increase their value. Finally, society as a whole should be concerned about the current global problems and the ways and situations in which they are addressed, as this ultimately affects each of us socially and financially.