Some of the largest and most influential institutional investors and asset managers are at the forefront of a powerful movement to add environmental, social and corporate governance (ESG) standards to their capital allocation criteria. As stewards of long-term capital, they recognize the mandate to consider whether the companies they own today will maintain a strong connection to both their customers and extended communities as environmental and social challenges increasingly impact the way we live and work. They also recognize that companies that commit to addressing these pressing issues can gain greater business opportunities in the future and will therefore achieve greater returns for their shareholders over the long term .
Measuring the impact of sustainable finance
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The total social impact (TSI) is a framework that companies and investors can use to diagnose specific levers that drive both total shareholder return and social impact. BCG recently used TSI to study the relationship between, on the one hand, performance on ESG issues such as inclusive supply chains and environmental impact, and on the other, market valuation multiples and margins. BCG found that ESG metrics were statistically significant in predicting valuation multiples for companies in all the industries it analyzed. In addition, investors rewarded top performers on specific ESG aspects with multiples that were 3% to 19% higher, all else equal, than those of median performers. Top performers on some issues had spreads as much as 12.4 percentage points higher.
This contrast is likely to become more dramatic over time as sustainability considerations move closer to the bottom line in many companies.
No longer a niche practice
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To protect against exposure to such events, investors understand that they can no longer treat sustainable financing as a niche practice. Asset managers are also increasingly shifting away from policies that seek to avoid risk by excluding specific securities in favor of strategies aimed at benefiting from companies that perform better on TSI issues. Examples include thematic and best-in-class best-in-class investments; impact investments, such as low-carbon indices and green bonds; and looking for companies that score well on gender diversity. At the moment it is known that in Central America a company in the Bosch Gutierrez family has issued a strong amount of green bonds.
However, these are still early days. Soon, we are likely to see sustainable finance become a more integrated intentional approach. Investors will apply ESG integration and best-in-class analysis across all asset classes to improve their risk and return performance. Active ownership will also become an integrated model, with investors routinely engaging with boards and CEOs in companies’ efforts to increase diversity and address their environmental performance, just as they do now with executive compensation, corporate governance and shareholder rights. Standards and negative screening will be used to inform engagement, not trigger exclusion.
Driving these developments is the increasingly critical roleprivate sector companies will play in addressing climate change , diversity and other major social issues, with major investors pushing them down this positive path. However, translating this investment strategy into tangible financial results for shareholders, both in the short and long term, requires knowledge of the steps companies must take to increase the impact and sustainability of their business models.
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