Understanding sustainability will be crucial to driving future growth

rethink sustainability

Understanding sustainability will be crucial to driving future growth

Sustainability issues were once seen as irrelevant to companies and investors, an inconvenience incompatible with the business of making money, except for a few 'responsible' investors who were happy to accept lower returns in order to 'do the right thing'.

That is no longer the case. Environmental, Social and Governance (ESG) issues are increasingly taking centre stage as it becomes clear that these factors can have a serious impact on company performance — and on returns to investors.


Key Trends Shaping the Sustainability Conversation

'Megatrends' such as climate change, demographic shifts, resource scarcity, increasing digitisation and a rise in inequality are creating profound, long-term challenges that companies need to understand in order to prosper.

The problem is that these changes are happening quickly, sometimes more quickly than our ability to understand them — or the government's ability to regulate. The rapid growth of technology behemoths such as Facebook, Google and Amazon has created issues for society but also for the companies themselves. Some recent examples show just how extreme the problems can be. Facebook has struggled to deal with the fallout from the demise of Cambridge Analytica . Google saw staff resign following revelations that the US military is using the company's artificial intelligence technology to develop autonomous drones. And multiple companies, including Amazon, are facing concerns over privacy as a result of the increased use of digital assistants like Alexa.

In addition, the actions of companies, their suppliers and their large-scale customers are becoming much more widely exposed thanks to social media and the greater availability of data. This was illustrated with the rapid demise of the Weinstein Corporation following claims against co-founder Harvey Weinstein.


How ESG Issues Are Impacting Companies

Consumers and citizens, particularly millennials who are just starting to flex their spending muscles, are more informed and concerned about where the products they buy come from, the conditions of the workers who make them and the sustainability of companies' operations. And they're not holding back when it comes to telling firms, their friends and their elected officials what they think.

The increased pressure on companies to be more sustainable isn't just coming directly from customers but also from politicians and regulators, who are developing new policies to respond to the growing clamour of voters calling for increased corporate responsibility. One example of this is the proliferation of regional and national governments introducing climate change rules. According to the Grantham Research Institute on Climate Change and the Environment, “all 197 Paris Agreement signatories or ratifiers have at least one law or policy on climate change"1.

The increased pressure on companies to be more sustainable isn't just coming directly from customers but also from politicians and regulators, who are developing new policies to respond to the growing clamour of voters calling for increased corporate responsibility.

Growing Interest in ESG Issues Among Asset Managers and Investors

As financiers become more aware of the risks created by sustainability issues, they are directing a growing proportion of their funding towards more sustainable companies.

A company's ability to manage environmental, social and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth.

Earlier this year, Larry Fink, CEO of the giant asset manager Blackrock, wrote to the CEOs of all the companies the firm invests in. He said: “The public expectations of your company have never been greater. Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society," he said.2

Blackrock is not alone in increasing its focus on these issues. A recent survey conducted by the Morgan Stanley Institute for Sustainable Investing and Morgan Stanley Investment Management found that 84% of asset owners are pursuing or considering ESG investing.3

The increased prominence of these issues is opening up a whole new world of opportunities for firms ready to take up the challenge.

Meeting the targets of the Paris Accord on climate change, for example, will create a $23 trillion investment opportunity by 2030, according to the World Economic Forum.4

The need to transition to a low-carbon economy is leading to huge growth in sectors that are crucial to this transition, such as renewable electricity, electric vehicles and energy efficiency. This, in turn, is rapidly reshaping the energy, utility and automotive sectors.

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The United Nation's Sustainable Development Goals, which 193 countries signed up to in 2015 (the same year as the Paris Accord), will drive new opportunities in the sustainability investment market. The 17 'Global Goals' focus on the key sustainability issues the world needs to tackle. According to the Business and Sustainable Development Commission, they "offer a compelling growth strategy for individual businesses, for business generally and for the world economy". Achieving the 'Global Goals' could create up to $12 trillion in market opportunities in sectors such as food and agriculture, transportation, energy, natural resource management, and health, the Commission says.5

What does all this mean for investors? First, they need to be able to identify those companies that are well-placed to benefit from the growing focus on sustainability — as well as those companies most at risk. This is becoming easier thanks to the growing amount of available data, along with the tools to analyse and interpret it.


What Makes a Company Sustainable

With this growing focus on sustainability, companies need three characteristics to succeed: a sustainable financial model, to be run in a sustainable fashion and have a sustainable business model.

Companies with sustainable business practices look beyond shareholders and also consider the needs of a broad ecosystem of stakeholders. This means taking into account regulators, employees, clients and suppliers, as well as the impact of their business practices on the local community and the environment. Companies with a sustainability strategy have a concrete plan for tackling the challenges raised by the mega trends such as climate change, the depletion of natural resources, changing demographics, inequality and the digital age. Companies looking to address the challenges of climate change and resource scarcity may be involved in clean energy, smart grid services, electric vehicles or renewable energy storage. Conversely, carbon-intensive companies will find themselves at a disadvantage and may struggle to attract investors over the long term.

A sustainable financial model requires that companies use capital efficiently, generate cash flow and not be over-reliant on the capital markets to balance the books. The model also needs to ensure the overall solvency of a firm can be assessed, including the credit quality and the ability to pay back debt or refinance.

Understanding sustainability will be crucial to driving future growth. If the customers will chose products and services from a sustainable point of view, companies will automatically adapt their business models quickly to stay competitive - and investors will follow. Identifying and targeting the companies that already incorporate ESG policies in their strategies is the crucial point of understanding the growth of tomorrow.

1 http://www.lse.ac.uk/GranthamInstitute/publication/global-trends-in-climate-changelegislation-and-litigation-2018-snapshot/
2 https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
3 https://www.morganstanley.com/ideas/asset-owners-embrace-sustainable-investing
4 https://www.weforum.org/agenda/2017/01/unlocking-23-trillion-of-climateinvestment-opportunities-is-mission-possible/
5 https://www.un.org/pga/71/wp-content/uploads/sites/40/2017/02/Better-Business-Better-World-Executive-Summary.pdf

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