Although the overall assets managed with a socially responsible investment/environmental, social, and governance (SRI/ESG) approach show above-average growth rates, this approach has not yet reached the mainstream investor. Since the trend toward sustainable investing is expected to strengthen further, this might soon change.
One of the reasons given by asset managers for why they do not implement SRI/ESG criteria in their investment approach is that they do not expect the criteria to yield an increase in performance for their portfolios. Negating this widely used explanation, the study “From the Stockholder to the Shareholder,” conducted by Arabesque Asset Management and The Smith School of Enterprise and the Environment (SSEE)—an interactive hub within Oxford University—shows that engagement (“active ownership”) can improve the operations and stock market performance of corporations. The study was conducted as a meta-study that analyzed more than 160 academic studies, industry reports, and books.
The key findings of the study are that 90% of the analyzed studies on the cost of capital show that high sustainability standards lower the cost of capital of companies and therefore contribute to higher free-cash flow. In addition, it seems superior sustainability standards improve corporations’ access to capital in general. The authors conclude that good corporate governance structures such as the absence of anti-takeover measures, small and efficient boards, and good disclosure policies are most important in reducing the cost of capital.
In addition, 88% of the analyzed research shows that robust ESG practices result in better operational performance of firms. The study shows that issues such as board structure, executive compensation, anti-takeover mechanisms, and incentives are viewed as the most material governance issues. In addition, environmental topics such as corporate environmental management practices, pollution abatement means, and resource efficiency are cited as most relevant to operational performance. Therefore, it is not surprising that 80% of the studies show that the stock price performance of companies is positively influenced by good sustainability practices.
One way investors can influence corporate behaviour and benefit from improvements in sustainable business practices is through active ownership. Active ownership describes a set of tools (proxy voting, shareholder proposals, management dialogue) for investors to influence companies’ sustainability issues. As shown in the Arabesque/SSEE study, empirical research points to the importance of shareholder proposals as a governance mechanism and that successful management engagement results in better stock returns. The authors conclude that active ownership is a powerful tool. However, in its current form active ownership lacks the support of the “general customer”—key stakeholder groups of the investee companies. The study’s authors think the future of sustainable investing is likely to be active ownership by multiple stakeholder groups, including investors and consumers.
From my point of view investors should always exercise their shareholder rights, since they are the owners of the respective corporations and are (at least financially) responsible for the actions taken by management. As shown by many research studies, it is in the best long-term interest of corporate managers and investors to include sustainability in strategic management decisions. That said, asset managers also need to act in the best interests of their investors (whether institutional or retail) to fulfill their fiduciary duties. That is, they need to exercise their access to the management of corporations to question strategic decisions as to whether they are in the favor of the investors. This also includes voting at shareholder meetings.
To monetize the advantages of sustainably acting companies, asset management companies need to integrate sustainability parameters (“nonfinancial information”) into their investment process to achieve competitive risk-adjusted performance over the medium to longer term and to fulfill their fiduciary duty toward their investors.
The full study — “From the Stockholder to the Shareholder“ — can be found on the homepage of Arabesque Asset Management: http://arabesque.com/