This paper follows weeks of intensified debate over whether the market for investments with explicit social value attributes will ever take off, and what is needed to unlock the potential so many have been chasing. It’s also timely, as it has been a frustrating couple of years in the investment world, both for “sustainable” and mainstream markets, as discussed in the June Calvert Gateways to Impact report, and bemoaned at last month’s SOCAP conference, as well as by sovereign and pension fund investors seeking yield. DB’s analysis doesn’t try to crack the whole nut - but it does give us a level-headed research driven analysis, new vocabulary, and actionable insight which, like many of the best ideas, is surprisingly simple.
The key conclusions:
Sustainable Investment (specifically, investments scoring high on Corporate Social Responsibility (CSR) and Environmental, Social and Governance (ESG) factors) is:
1) Good for Investors… because it consistently result in higher performance.
2) Good for Companies.... because it consistently results in lower cost of capital - both loans, bonds and equity. Therefore sustainability (actually, CSR and ESG) should be the concern of not just the Sustainability Officer and CEO, but also the CFO.
This is not entirely surprising, and certainly not a new perspective, but the format of the Deutsche Bank analysis provides fresh tools to advance the conversation.
Why this publication matters:
- High-Level Analysis - The analysis is a terrific addition to the discourse, because it provides one of the most comprehensive literature reviews to-date, and establishes a framework to compare diverse articles published on the subjects.
- Results by Group - The review breaks the world of “sustainable investing” into sub-groups: CSR, ESG and “Socially Responsible Investing” SRI, and evaluates relevant research from each category, analyzing corporate financial performance, cost of capital, and, in the case of SRI, overall fund performance. Grouping these categories shows patterns not entirely visible in any individual study- namely that SRI strategies are NOT correlated with either higher performance or enhanced cost of capital, but high marks on CSR, specifically governance issues, are.
- Finally, Webster for SI - Two of the most useful pages in the entire paper are the defines sheets – bullet pointing what in the world the difference is between Responsible, Ethical and Sustainable Investment (?!!), and discusses the evolution of each category.
- This is basic, but extremely constructive, since any new meme requires time to converge on standard definitions. The loose and interchangeable use of ‘social investment’ vocabulary is in itself a barrier to meaningful communication and can instigate exhaustion and eye-rolling from investors who just want to know what in the world is being discussed. At a minimum, the definitions give investors a menu of concepts with which to frame their objectives.
So what do we take away from this- other than a good high-level view and a little more scaffolding from which to approach these issues?
Choose your words
The paper addresses the universe of “sustainable investments” – but rightly describes this term as a “catch-all.” The breadth of term and others make it a blunt tool, encompassing too many ideas to communicate effectively, drive decision-making or warrant generalization. For anyone involved in this industry space, it is worth explicitly defining the rationale and mechanics of what is being proposed – as the vocabulary is neither constant nor intuitive, and some strategies are quantitatively more effective than others.
Post Crisis analysis
The paper specifically addresses base research pre-2008. It would be worthwhile tracking any longitudinal studies to see whether crisis conditions have exacerbated or reduced the benefits of ‘CSR’ strategies.
Sustainability = Long Term Investment Mentality
The positive results found are not related to any specific asset class, investment structure, new market or innovative way of pricing externalities. Rather, the components of sustainability cited sound a lot like common sense long-term investment discipline.
Specifically, better corporate performance and lower cost of capital were supported only for CSR and ESG initiatives: “an approach to business that takes into account economic, social, environmental and ethical impacts for a variety of reasons, including mitigating risk, decreasing costs, and improving brand image and competitiveness. This approach is sometimes implemented by means of a comprehensive set of policies and procedures integrated throughout a company, encompassing a wide range of practices, including: corporate governance, employee relations, supply chain relationships, customer relationships, environmental management, philanthropy and community involvement.”
So we are talking about investments in corporations which score higher than peers on attributes that “mitigate risk, decrease cost, and improve brand image and competitiveness?” Is anyone surprised that these issues would be correlated with higher performance and lower cost of capital?
These issues and the governance and leadership policies described above are core to proper due diligence on any operating company. With the exception of short term arbitrage or volatility trades, I cannot imagine recommending any investment WITHOUT requiring above-average marks on nearly every one.
In 2004 the UNEP Finance Initiative posited that “environmental, social and corporate governance issues affect long-term shareholder value…and in some cases those effects may be profound”… In the words of my younger brother – no shit, Sherlock.
In a much earlier DB report, Analysts referenced McKinsey CEO Dominic Barton’s ‘Capitalism for the Long Term” - stressing long term strategies as critical for sustained growth. Business strategy is McKinsey's bread and butter - and Barton's suggestions are consistent, albeit broader reaching, with the specific attributes of CSR and ESG highlighted in this week's DB report. The key takeaway assuming a decent buy price: corporations which address a more comprehensive set of long term factors make for better investments, in the long term. Sustainable = long term.
This analysis ignores the entire concept of investing in business models which are themselves explicitly sustainable in an environmental or social way, such as renewable energy production, microfinance, or energy efficiency. However, if adding new vocabulary helps us focus on the issues of long term survival - we may end up at the same conclusions, eventually.