Sustainable Investing-Innovation and Lessons Learned

Sustainable investing has increased in popularity for investors to reap both the financial returns while “doing good” for society and paving the way for future generations to continue investing with this dual motive.

An EisnerAmper webcast titled “Sustainable Investing -- Innovation and Lessons Learned” discussed the topic.  

Panelists included:

• ESG Strategic Solutions, Director EisnerAmper
• Preeti Bhattacharji, head of sustainable investing, J.P. Morgan Private Bank
• Christina Burck, vice president, J.P. Morgan Private Bank

Discussion included:  

Sustainable Investments Generate Both Financial and Societal Returns

It is well known and documented in academic literature that sustainable investments generate positive financial and societal returns. To help investors understand the reason for these long-term gains, first it is important to examine the principles of risk management, transparency, business ethics, and good corporate governance. Investors must put themselves in a company’s shoes and understand the challenges it faces to manage the expectations of various internal and external stakeholders.

Causes of Sustainable Returns

Further, to understand sustainable investments and why they generate positive financial returns, investors must understand the causes of these good, sustainable, intergenerational financial and societal returns. It might seem obvious but most of the time it is neglected as investors tend to fall into the traps and fallacies of correlation and volatility analysis. Explaining financial returns by correlation analysis only can be misleading and lead to spurious conclusions.  Remember the maxim: Correlation does not mean causality. This is valid in sustainable investing more so than ever before.

To understand the causes of good and sustainable returns, it is important to recognize the transmission channels that link environmental, social, and internal governance factors to the financial performance of the company and develop a fundamental understanding of the ESG characteristics of the company and how those affect their financial statements and risk profiles in the short-, medium-, and long-term. With good insight into these financial impacts, investors can then understand the company’s valuation.

All types of investors, across asset classes from family offices to private equity, institutions and more can utilize their analysis to integrate ESG concepts in their investment strategies and tailor them to their own fiduciary requirements.

ESG Risk Factors for Companies to Achieve Bottom Line

Investors must also understand how ESG risk factors impact a company’s bottom line including cash flow, income statement (revenues and expenditures), and balance sheet, which will give a solid idea of the cost of capital, and how easy it is for the company to have access to finance. Naturally, ESG factors and how they impact a company’s financials may not be straightforward, and inherently depend on the nature of its business, strategy, industry sector and geographic presence.

In practice, a company with a more robust corporate governance will be in a much better position to have more robust ESG risk management. By understanding how these ESG risks and sustainability opportunities impact the company’s strategy and business model in the short-, medium-, and long-term, and by disclosing how those risks impact the various stakeholders, the company will have more solid financials. At the same time, it will reduce its cost of capital, and will have more solid and predictable cash flows, increasing its valuation.

ESG Leads to Stronger Resource Management

Companies with more robust ESG and sustainability practices will manage their resources more effectively, do a better job at attracting and enhancing human capital and managing innovation, and be able to tap into different markets and geographies, which could have a clear and sustainable influence on the bottom line while also increasing its valuation.

The Significance of ESG and Sustainability Best Practices

ESG and sustainability best practices for companies include robust corporate governance, and a management structure that enables it to identify the ESG risks factors and their corresponding sustainability opportunities (e.g., climate change risk factor linked to an energy efficiency opportunity, or the risk of high staff turnover mitigated by a strong diversity, equity, and inclusion policy and practice), and the financial impact of those risks and opportunities to its strategy and business models in different time horizons.

The onus is on companies to disclose those elements to the various stakeholders, including investors. Investors will have a better and much clearer understanding of how the companies sustain those results in different time horizons.

Consequently, better ESG and sustainability practices are good for the planet and, consequently, for our society, today and in the future. Guaranteeing sustainable societal benefits while bringing consistent and robust returns by integrating solid ESG and sustainability practices and providing all stakeholders with transparency, active ownership opportunities, and disclosures are the essence of sustainable investing.