ESG: short-term pain for long-term value?
What is ESG?
After attending two events and two webinars (held by Lansons, IR Magazine, the IR Society and Anthesis) on the topic last week, it’s easy to see why people get confused over the definition. When talking about ESG there are a lot of different terms and acronyms to get your head around and, often, ESG can mean different things to different companies and people.
Generally, it refers to the broad set of factors (environmental, social and governance) that are not measured in financial terms but are material to a company’s financial stability. Essentially ESG is a way of looking at risk factors.
The main takeaway from the discussions we attended last week is that ESG is not going away. In fact, it is growing in importance, to both investors and consumers, and companies must therefore get to grips with it and take action immediately.
Do investors care about ESG?
The act of ESG investment has increased immensely over the last few years. According to the Global Sustainable Investment Alliance, it accounts for nearly $23tn in assets under management worldwide. Much of this popularity is driven by a belief that more sustainable investment portfolios will outperform others. As we discussed in our “Do investors care about sustainability?” blog, this means that investors are becoming increasingly focused on how companies are managing and mitigating these issues.
What do investors want?
The particular areas of interest highlighted by investors at the recent events were:
- response to climate change;
- board diversity;
- compensation; and
It is important for them to see that ESG matters have been taken into consideration by the board and that the potential strategic repercussions of these risks are being minimised. Whilst it is important for investors to see that ESG has been integrated into the business process, they also want to see how it is adding value to the end client.
Interestingly, one investor from a leading asset management firm said that companies should not waste their time filling out surveys and benchmarking results on data platforms such as Sustainalytics and CSRhub. Instead they should invest time into communicating and articulating their material issues and explaining to investors why what they are measuring is of material importance, as well as how they plan to measure and manage these impacts in the future.
What should companies do?
A few years ago, it was common practice for IR teams to respond in an ad hoc way as queries came in about ESG issues. Now, it is best practice to be much more strategic and proactive.
Companies are expected to respond to market signals by communicating their ESG-related performance, producing credible data and, most importantly, ensuring that this narrative links to their business strategy.
Don’t chase every index
Ratings can be very expensive and time inefficient. Understand what handful of indices your investors are really looking at. There is a benefit of being on a list but there is no need to be on all of them.
Speak to your stakeholders
Materiality varies by sector and business activity, and companies should therefore focus on the top issues that affect their bottom line.
Reaching out and engaging with investors and stakeholders regularly can help companies gain a good understanding of what is important and relevant.
Investors want data!
No surprise here, it’s just the way it is. Companies should ensure that their ESG story is supported with data and demonstrate how this is connected to the business strategy. This data should be robust and credible, just like financial data, and should be easily accessible.
Where should data go?
A few years ago, there was a real push to separate sustainability information from the annual report. However, any smart investor understands that the companies with the foresight to think of ESG are going to be leaders in the industry; they will anticipate and react successfully to risks. It is for this reason ESG data should be fully integrated into your key communication materials, such as the website and annual report.
You can learn more about how to present ESG information by reading our Guide to ESG Reporting.
ESG can be transformational for businesses as this data is used more and more in investment decision making. Companies must understand the specific ESG issues that are relevant to them and provide this data in a way that is easily accessible.
The topic of ESG may seem to be led from the investment community, but it is important to always keep in mind that ESG is about long-term sustainability and doing good for the planet. Companies should not only listen to investors but also their clients/customers. They should understand their beliefs and create product innovations based around this.
ESG may not lead to automatic outperformance, but it doesn’t hurt performance either. It requires a lot of resources and tools and there must, therefore, be a willingness from companies to accept lower short-term financial returns for greater long-term value creation.