This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 18 - 24, 2016.
Investors the world over are putting their money in companies that adopt sustainable business practices. Those who ignore this growing trend do so at their peril.
Responsible investing is slowly but surely gaining traction across the globe. More and more funds are being invested in companies that practise sustainable business.
According to news reports, the UN-supported Principles for Responsible Investment (PRI) initiative has some 1,380 signatories under its umbrella, representing US$59 trillion (RM235 trillion) in assets under management. PRI is an international network of investors who subscribe to the principle of responsible investing.
Companies that ignore this growing trend do so at their own peril. Last year, Volkswagen AG saw its shares (listed on the Frankfurt Stock Exchange) plunge 23%, wiping out about €15.6 billion in market value, after US regulators found that the automaker had been rigging the emission controls in some of its diesel-fuelled cars.
It subsequently posted a net loss of €1.58 billion for the year, compared with a net profit of €10.85 billion in 2014, partly due to the scandal that saw the company admit that 11 million of its vehicles were equipped with software that was used to cheat on emissions tests. Volkswagen, ranked among the world’s most responsible companies, was eventually dropped from the Dow Jones Sustainability Indices and the FTSE4Good Index Series.
Back home, Malaysia’s second largest palm oil producer — IOI Corp Bhd — lost four big clients in April after the Roundtable on Sustainable Palm Oil (RSPO) suspended its sustainability certification. The four companies — Nestlé SA, Kellogg Company, Unilever plc and Mars Inc — are committed to using certified sustainable palm oil in their supply chain.
IOI’s shares tumbled 11.54% and the company lost RM3.4 billion in market capitalisation between March 30 and May 31. Following the suspension, IOI filed a lawsuit against the RSPO, only to withdraw it last month. Instead, it has promised to engage the parties involved and to come up with an “action plan” that will bring it in line with the RSPO’s accreditation.
These events are just some of the numerous others that have underscored the importance of environmental, social and governance (ESG) factors in measuring the sustainability and ethical impact of an investment.
Understanding that it takes more than corporate businesses to shape sustainable capital markets and to stay competitive, leading stock exchanges around the world have implemented corporate education programmes and sustainability-themed indices and set minimal standards for sustainability disclosure as a prerequisite for companies to list on those exchanges.
This move coincides with the global shift among money managers to increase exposure to responsible investments. According to the Global Sustainable Investment Alliance, sustainable assets under management grew 61% to US$21.4 trillion between 2012 and 2014. But Asia ex-Japan — where responsible investing is still at a nascent stage — accounted for only US$53 billion of the total. This compares with Europe’s US$13.6 trillion.
In Asean, Bursa Malaysia was the first stock exchange to work with an international body to launch a FTSE4Good (F4GBM) index in December 2014. The index comprises 38 constituents made up of public-listed companies in the small, medium and large market capitalisation segments. Malaysia is also part of the UN’s Sustainable Stock Exchanges (SSE) initiative.
“We started [the index] with 24 companies. Now, there are 38. Although it is a small proportion of the stock exchange, this is where the future lies,” says Bursa Malaysia CEO Datuk Seri Tajuddin Atan. The assessment of the companies for the index was financed by the Capital Market Development Fund.
The index’s constituents are drawn from the 200 shortlisted companies on the FTSE Bursa Malaysia Emas Index and reviewed annually in June and December against international benchmarks developed in collaboration with global index provider FTSE Russell.
“We embarked on this journey so that everyone is responsible. It is not about us telling you what to do, but about accepting sustainability as a way of life,” Tajuddin tells Personal Wealth.
He says it is evident that some businesses are more toxic than others, but adhering to ESG standards enables companies to give back what they take from the entire ecosystem and do better financially in long run.
FTSE Russell ranks Malaysia as an advanced emerging country, so companies need at least a rating of 2 to be listed on the F4GBM index. “FTSE Russell told us that we had the option to set the bar lower if need be, but we decided to stick to international standards. In the eyes of foreign fund managers looking at Malaysia, they know that we have kept to international standards.
“This is the next phase of the journey. We have already captured those who are ahead of the game in the FTSE4Good index, but we need to parade the mid-sized and small companies,” he adds.
To prepare more companies to get on board the F4GBM, Bursa Malaysia has introduced a sustainability guide and toolkit, which provide new model guidance for other listed companies.
The Stock Exchange of Thailand was the first to publicly commit to promoting sustainable practices in accordance with the SSE initiative, which promotes sustainability performance and transparency in capital markets. It is believed that the Thai stock exchange plans to launch a sustainability index in collaboration with Dow Jones.
The Singapore Exchange is also in the process of coming up with its own index, while the Indonesia Stock Exchange has collaborated with the Indonesian Biodiversity Foundation (Kehati) to assess the performance of companies on corporate social responsibility.
Investors believe sustainability performance reduces a company’s risks
A recent sustainability report, published by the Boston Consulting Group (BCG) in collaboration with MIT Sloan Management Review (MIT-SMR), showed that a growing number of investors are paying attention to ESG factors. The report quoted findings that debunked the myth that investors have to compromise on returns when practising investing with a conscience.
One of the key takeaways from the report titled Investing for a Sustainable Future: Investors Care More about Sustainability than Many Executives Believe is that investors believe sustainability creates tangible value.
“[According to the survey,] 75% of the respondents cite improved revenue performance and operational efficiency from sustainability as strong reasons to invest, more than 60% believe solid sustainability performance reduces a company’s risks and nearly the same number strongly believe it lowers a company’s cost of capital,” says the report.
This is because investors see a strong link between corporate sustainability performance and financial performance, says Alexander Meyer zum Felde, who is BCG’s Hamburg-based project leader for sustainability.
Investors — from retail investors and asset managers to institutional investors — are focused on investment returns and will continue to do so in the future, says Felde, who co-authored the report with Gregory Unruh, David Kiron, Nina Kruschwitz, Martin Reeves and Holger Rubel. “Yet, what we have seen is that incorporating environmental and social aspects into [the company’s] strategy leads to higher financial returns,” he tells Personal Wealth in an email interview.
Felde says investors are increasingly convinced that sustainability performance is crucial as it is related to increased transparency. “Having a good sustainability [plan] goes hand in hand with increased transparency, be it your suppliers in your value chain or understanding the premium price potential of customer demand. Creating this transparency helps to identify pitfalls early and to better manage risks. Moreover, transparency usually creates stronger governance models and enforces certain values.”
The report notes that investors are prepared to divest holdings in a company with a poor sustainability performance record while 60% of the board members of investment firms say they are willing to divest shareholding in companies with a poor sustainability footprint. It adds that 60% of the board members of investment firms see a company’s sustainability performance as materially important to their investment decisions and nearly half (44%) would not invest in a company with a poor sustainability track record.
For the majority of investors surveyed — more than 70% — sustainability is central to their investment decisions. However, despite the shift in investor sentiment, the survey found that many corporate executives still buy into the belief that mainstream investors care little about an organisation’s ESG performance
The survey compiled responses from 7,011 respondents from 113 countries, but the report was based on a smaller subsample of 3,057 respondents from commercial enterprises. Within this commercial sample, 579 respondents self-identified as investors, of which most were strategic (39%), institutional (24%) and retail (11%) investors.
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