Environmental, Social and Governance – three words that we now hear all the time when analysing and discussing investment. And three words that need to be an integral part of the due diligence for every investment decision. If you want to attract substantial investment into your business then you now need to make sure that your “ESG” story, policy and monitoring is solid and coherent.
There was a time when “ethical” investment was its own niche. Those who aspired to be ethical, or had deluded themselves into believing that their ethics were central to their business practice, charged into ethical investing. “Ethical investment” was plastered all over investment products and people who thought ethical investment reflected their beliefs, morals and personalities bought into products that were not really intelligent, profitable or ethical! That seems a very long time ago.
The next stages in the development of investment with accountability were funds that truly were ethical and, to everyone’s surprise, they were also profitable. Some of the most successful ethical funds, ISAs and bonds, outperformed their unethical rivals. Where the more traditional funds were achieving very pedestrian returns of around 4% the ethical funds were achieving nearly twice that level. I suspect that the reason for this was that the due diligence necessary to ensure ethical compliance meant that the idle analysts did their jobs properly and researched the investments to a much greater extent than they had previously done. But then I am a cynic.
A digital world connecting our global village now means that the analysis of a business in terms of what it does, how it does it, and how it impacts its staff, clients, suppliers and the rest of humanity is no longer an option but a necessity. The impact on businesses that generally operate “just-in-time” models to disruption in any part of its business and supply chain can be terminal. That means that every business needs to understand not only its own ESG impacts but also those of its suppliers and clients. If I am a clothes manufacturer and my biggest customer is a retail clothing chain that routinely exploits its staff, offers poor customer service, and buys from other suppliers in countries that operate the 2020 equivalent of slave labour then I am almost certainly going to have a problem in the future.
ESG: Environmental, Social, and Corporate Governance refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business. And if the business you are considering investing in does not have a cohesive ESG strategy then leave well alone. Because these criteria help to better determine the future financial performance of companies.
I have helped a number of businesses and investment funds to build systems that allow them to operate a coherent ESG strategy. The starting point is to understand the scope of the three terms:
- Environmental Concern – the effect that my business has on climate change and the inherent sustainability of the business. This will not just mean looking at my manufacturing, logistics and recycling but everything that my business does from waste and water management through travel types and frequency, and even the question of working practices, for example whether office attendance is necessary. The issue of sustainability is increasingly crucial. I might sell the most carbon-neutral product in the world but if I package it in single-use plastic I fail miserably.
- Social Concern – the effect that my business has on its staff, the communities where it is based, and its customers. Do I have diversity targets to ensure that the mix of my workforce reflects the demographics of my society? Am I certain that all my suppliers respect the human rights of their employees? Am I ensuring that the business does not harm but rather benefits the community in which it is located? And am I ensuring that anything that I manufacture, supply, recommend or distribute offers safety, value, quality and ease of operation for my customers? The days of “Caveat Emptor” (buyer beware) are ancient history.
- (Corporate) Governance Concern – How do I structure and manage my business? Corporate governance covers the area of investigation into the rights and responsibilities of the management of a company—its board, shareholders and the various stakeholders in that company. If this is wrong then everything below it will be wrong as well. The most important factor is the management structure — attention has been focused in recent years on the balance of power between the CEO and the Board of Directors. Employee relations are also a key factor when looking at profitability. If a company appears in a list of Best Companies to Work For it will almost always have a noticeable impact on company values. And lastly, one of my favourites is the multiple between executive and employee compensation.
Businesses that take ESG seriously are uniformly more successful than their competitors that do not. Some of that may be because, as I previously suggested, any business that has not thought through this aspect of its mission is not competent or credible elsewhere. Some of it is because the digital and ethical consumer acts fast and aggressively – witness a 50% collapse in Boohoo’s value based on a sweatshop manufacturing exposé by a newspaper. 50%!!!!!
Businesses are forced to reflect the interests, likes and dislikes of their customers. And the biggest percentage of active buyers is now Gen X’ers, Millennials and Gen Z’ers – who all have a more focused perspective on the morality and consequence of business, finance and acquisition than earlier generations.
At Investment Owl we always research the ESG aspects of the businesses that we raise money for and we continue to believe that this is crucial to our analysis. But it is no longer just about making sure that the investments are not doing bad stuff. Increasingly, we want the businesses, ideas and opportunities that we promote to have a positive impact on the world and humankind. That is why medical cannabis, biofuels, MedTech, EdTech and inclusive FinTech are the investments that we are seeing attract capital spending and exceed expectation at the moment. Building wealth and building a better world do not have to be mutually exclusive!!
Jon Pedley is Chief Operating Officer, Investment Owl.
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