I recently attended the annual conference of the CFA Institute, the largest association of investment professionals in the world. This blog post is based on remarks I gave at a panel discussion, “Sustainable and Responsible Investing: Can Markets Save the World?” Notably, this is the first time the Institute has hosted a plenary session on sustainable investing at its annual conference.
Palm oil plantation workers in Sumatra, Indonesia. Wilmar, a leading Asian agribusiness group, which trades more than 45 percent of the global palm oil supply, is committed to a deforestation-free supply chain. Photo Credit: CIFOR/Flickr.
Most of the ingredients for a healthy, secure, and fulfilling existence come to us from nature. Food, clean water, pollination, and natural hazard protection are all essential goods and services that underpin our economy and secure our well being. But business models that exploit these benefits unsustainably are intensifying pressure on our planet’s natural resources, putting their future—and ours—in jeopardy. How can we relieve this pressure before it is too late?
As a first step, we need to recognise that rapidly declining natural systems are bad news for business. There is a two-way street between the economy and the environment: businesses damage the environment, and the damaged environment then creates risks to the bottom lines of businesses.
But why should members of the investment community care? After all, they are not trying to save the world; they have a fiduciary responsibility to generate returns to their shareholders. Three reasons explain why investors should include sustainability considerations in their decisions, and why doing so is compatible with fiduciary responsibility.
1. Environmental degradation and the impacts of climate change are material business risks
A World Economic Forum global risk survey of more than 700 leaders identified sustainability issues—water, extreme weather and climate change—as top global business risks. Environmental degradation and climate change create unexpected risks in corporate value chains—not just environmental risks, but business risks.
Companies in the food sector are especially vulnerable. Asda, the British supermarket chain owned by Walmart, for example, found that 95 percent of its fresh product lines are threatened by climate change. When drought in the U.S. Midwest hit grain production, the earnings of Archer Daniels Midland, a U.S. processor of crops, took a hit, even months after the drought broke: its second quarter earnings in 2013 fell by 21 percent amid weaker grain-handling profits.
The interconnected nature of environmental threats can also result in cascading risks. Consider the case of Anheuser-Busch, the world’s largest beer brewer. Drought in the U.S. Pacific Northwest in 2001 severely affected its operations. When the amount of water available for irrigation dipped, the price of barley, a key ingredient in beer, skyrocketed. At the same time, the availability of aluminum for cans dropped as smelters, which rely on low-cost power from hydroelectric dams, reduced output because of rising electricity prices.
The energy sector is another risk hotspot. Half of all shale reserves are located in water-stressed areas, and half of the world’s largest coal-producing/consuming countries are at risk of high levels of water stress. Energy companies depend on water for extraction and production (coal, gas, oil, biofuels), electricity generation (hydro) and cooling (coal, nuclear, gas). No water, no energy. Energy outages, in turn, create ripple effects across the economy. Water supply also depends on energy to power treatment plants and transport water through pipes. No energy, no water.
2. Companies that damage the environment can no longer hide
Companies now operate in a global fishbowl, with any flaws on full display. For example, NGOs are taking advantage of low-cost remote sensors, advanced information, communication technologies and social media to expose companies’ practices and hold them accountable for environmental damage. It’s now hard to hide bad things.
Lumber Liquidators, a hardwood flooring specialist, experienced this trend firsthand. Following a tip from an NGO, U.S. federal officials executed search warrants at the company’s headquarters last September related to the company’s wood imports. Its share price dropped 13 percent on the day of the raid, and it has still not recovered.
Investor-friendly tools that provide information linking companies’ operations and environmental conditions and trends are also emerging. The online tool Global Forest Watch, for example, provides high-resolution, near-real-time information on deforestation around the globe, helping to shine a spotlight on businesses that contribute to deforestation.
3. Sustainability is a major driver of business strategy and competitiveness
While the investment community continues to linger on the sidelines of sustainability, members of the corporate community increasingly view it as a source of competitive advantage. A 2013 UN Global Compact-Accenture CEO Study on Sustainability found that 63 percent of chief executives expect sustainability to transform their industry within five years. Similarly, a Ceres survey of 613 large U.S. public companies found that 24 percent of chief executives had sustainability linked to their compensation.
The Harvard Business Review has categorised sustainability as a meta-trend, along with information technology, globalisation, and mass production. Comprehensive sustainability commitments are now becoming commonplace among many major corporations. Philips has committed to investing €2bn (£1.6bn) in green product innovation by 2015. And Wilmar, a leading Asian agribusiness group, which trades more than 45 percent of the global palm oil supply, is committed to a deforestation-free supply chain.
Companies are also talking more about sustainability when they meet their investors. Ceres found that 53 percent of companies surveyed were engaging investors on sustainability initiatives, up from 40 percent in 2012.
A specialised section of the investment community (socially responsible investment (SRI); and environmental, social, and corporate governance (ESG) is already taking steps to shift investments away from businesses that harm the environment toward businesses that are better stewards of nature.
But these enlightened investors represent only 10 percent of all investment dollars—they can’t save the world on their own. If the other $50tn-plus of globally managed assets handled the risks in their portfolios better, the market could indeed play a role in helping secure a sustainable future—for the environment and for business.
The CFA institute, Certified Financial Planner Board of Standards, and other investor professional associations should prioritise training the next generation of financial analysts how to integrate sustainability into investment and lending decisions—not just those with SRI or ESG labels. This will require a shift in how investors view sustainability—from a do-good issue to a must-do consideration.
It will not be easy, but the consequences of business as usual are unthinkable. As Nelson Mandela said: “It always seems impossible until it’s done.”