Failure diagram

Do sharemarkets really reflect social and environmental risks?

As an investor with some shares in my personal and superannuation portfolios, I have in an interest in the future prospects of companies. I contemplate what pitfalls and windfalls lurk in the future. The sustainability of these companies.

But I’m jumping ahead. Let’s start with “what factors determine future value of stock?”

As we all know, that’s a complex question. If it was simple, we’d all be billionaire traders. But let’s just say there are many factors, many of them linked to supply/demand cycles, commodity prices, social behaviours, competition and so on. One group of factors that is getting increasing attention comprises environmental, social and governance (ESG) factors.

Why ESG factors?

Why would they be getting any real attention?

  1. The first reason is broad. If you take the view that businesses that add ongoing value to society have a better chance of flourishing over a long period, then it would be prudent to look for those. So, businesses that solve a societal need (energy, food, raw materials, aged care etc) qualify. In fact, a lot of industries qualify.
  2. The second reason is more pointed. There may be some ESG risks associated with the industry or business. Stakeholders (customers, investors, governments etc) may pull back from businesses that are not managing these well. If a community may shut down a mine, or climate change induced droughts may affect food production, then a smart investor might shy away from businesses exposed to these undesirable risks.

ESG factors, once the purvey of “green” investors and “ethical” investors, the language has shifted. Notably from “green” and “ethical” to “responsible”. And why is it responsible?  Because in the mid to long term, ignoring ESG factors risks eroding or destroying value. Ignoring ESG factors might be irresponsible investing.

What scale are we talking about?

Of course these ESG actors don’t always overwhelm your decisions. The community may shut down the mine but the price of the mineral may be skyrocketing; in which case a responsible investor might actually choose to keep investing in the mine. But downright ignoring ESG factors would seem myopic, especially if you took a long term view of investment.

Of the estimated $260 trillion in funds and assets under management in the world, about $60 trillion is held by fund managers who, on paper at least, claim to factor ESG risks into their investment choices. That’s not necessarily a public-relations media release (although it could be for some investors). It’s a signature on the UN Principles of Responsible Investment, so it has some basis of intent. The $60 trillion is not a trivial percentage of the total, but it’s the rate of growth of signatories that is interesting.

 

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It’s a relatively recent phenomenon, but anything that grows from a fledgling status to 20% of a market in 10 years bears watching.  You can find out more at https://www.unpri.org/.

And what are those ESG risks? Are they really that big?

Well the answer is “it depends on the business”, but the World Economic Forum’s annual risk report gives you a 30,000-foot clue.  You can find it at http://www3.weforum.org/docs/Media/TheGlobalRisksReport2016.pdf, and the following is an extract of the summary.

Global Risk Report 2016

Several ESG-type risks sit quite high on the graph.

Climate change is prominent. For a highly informed and impassioned investment view of this risk, the following “Tragedy on the Horizon” speech on financial stability, by Bank of England’s Mark Carney,  https://www.youtube.com/watch?v=V5c-eqNxeSQ&t=325s is worth viewing.

Who is taking this seriously?

There is a lot of rhetoric in the institutional investment community and in the business community about ESG factors. Not everyone is convinced it’s a real thing. Some are convinced but have concluded that paying it lip service is sufficient to keep stakeholders at bay for now. A convinced percentage have determined that they need to diligently account them each year, if not for any other reason than to assure themselves that ESG factors are not draining value. Others – a relative few at the moment – have decided that these factors sit at a reasonably strategic level. They may not materially affect share prices in twelve months, but they might in five or ten years.

I see pennies dropping and dots joining at a slow but steady rate. The logic is sound. And even if there are no immediately catastrophic implications to this logic, there does seem to be some kind of stirring on the horizon. So institutional investors and businesses appear to be grudgingly paying ESG factors some attention, scratching their collective heads and – without panic or fanfare – figuring out what to do about it all. Which is fine. After all, it’s a relatively new issue in mainstream investing.

In my next post I’ll comment on what I’m seeing investors, securities commissions and businesses doing about it. There is movement at the station.

 

Posted in CorporateSpeak, Prosperity, Uncategorized.

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