Making more of E and S
If the importance of governance is well known, environmental and social factors tend to be harder to quantify and analyse in terms of how they affect corporate performance. And yet the ultimate beneficiaries for whom asset managers invest – individuals, pension funds and institutions – consider both to matter even more. In part, this perceptions gap could be down to differing time horizons.
Compared to environmental factors, governance issues can come to the fore much more quickly – which might explain their importance for asset managers, who are frequently measured on quarterly performance.
By contrast asset owners can reasonably expect to maintain their wealth for generations to come.
The hurdle here is that because environmental and social components of ESG are harder to quantify and time, they’re easier to ignore from a purely financial perspective. Like the guy who only looks for his lost keys under the lamp post, because that’s where the light is.
ESG performance is the corporate body language that gives a deeper insight than balance sheets alone can offer.
Still, a carefully designed approach can help to shed some light on how these factors play out.
For instance, serious environmental problems are often flagged up by a corporate culture that suggests a willingness to accept more minor infractions. So, for instance, BP’s Deepwater Horizon catastrophe was anticipated by the company’s poor environmental record elsewhere over a number of years.
Environmental costs aren’t just direct in the case of disasters. They can also disrupt supply chains. For example, some polluting motors are no longer produced. Companies that still use older versions and that fail to factor in these changes can end up with substantial development and maintenance costs.
Regulation provides a framework of rules for companies as well as a schedule that investors can track closely. This is especially true for environmental issues where regulation is catching up to growing public awareness. Take the new rules being imposed on global shipping by the International Maritime Organisation (IMO). From 2020, the IMO is cutting allowable ship fuel sulphur content to 0.5 per cent from 3.5 per cent by mass. How businesses are reacting offers an insight not only about their ESG credentials but about the quality of their management. Some shipping companies have already started to prepare; others are haven’t, leaving themselves open to significant costs down the road.
Elsewhere, Imperial College researchers found that climate change is pushing up borrowing costs in developing countries.5
Social factors are even more a case of appraising corporate body language. But the risks are growing increasingly clear. Pressure is on companies to close gender pay gaps and boost wages for the lowest paid. For firms with thin margins and large minimum-wage workforces, this shift could ultimately have a significant impact on earnings. Companies with poor employee relations or ones that fail to tackle issues like discrimination not only face potentially expensive workforce problems but risk damage to their brand value and reputation, especially as negative headlines are amplified by social media – as, for instance, Ryanair found to its cost. Others face opprobrium from how they’re perceived to treat users, like Facebook.