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Can Companies Turn a Profit while Investing in ESG?

By John Greenwood

There’s a growing movement around investing to bring about change for the better. And it turns out you can do good and make money doing so.

The past decade has seen a growing trend to invest in companies that do good, whether by protecting the environment, respecting human rights or simply acting ethically. Sometimes called socially responsible investing or sustainable investing, more often these days it’s referred to by the umbrella term environmental, social and governance (ESG). For years, conventional wisdom had it that ESG had no place in the business world. Making money and protecting the environment or treating aboriginal communities fairly were seen as incompatible.

You could be good or turn a profit, but not both.

It turns out conventional wisdom is wrong. “The myths around financial returns and sustainable investing have been debunked,” says Heather Lang, director of institutional relations at business data provider and sustainability consultants Sustainalytics. “Being socially responsible is becoming recognized as good business practice.”

Simply put, business leaders are paying attention to the impact their companies are having on the world around them, and they’re taking this into account in corporate decision-making.

Among top performers it’s now considered best practice to incorporate ESG thinking into company operations. “There is a strong correlation between companies that exert oversight over [ESG] issues and those that are well-managed and profitable,” says Lang. Bottom line: being socially responsible in your investing will help the world and it can also make you money.

According to the Responsible Investment Association (RIA), assets managed under sustainable guidelines were sitting at $600.9 billion by the end of 2011, the most recent period for which statistics are available, up a hefty 16% from the previous year.

Moreover, they represent about 20% of total assets under management in the Canadian financial industry.

So what’s driving this growth? One factor is that more companies are recognizing the importance of ESG. Against a backdrop of rising public concern around environmental and social issues, no CEO wants to be seen as part of the problem. There’s no shortage of examples of what happens when players end up on the wrong side of public expectations.

The Deepwater Horizon disaster of 2010 is now regarded as one of the worst oil spills in history. Thanks to social media and the Internet, the collapse of the BP oil rig in the Gulf of Mexico was also one of the most publicized. BP has taken a charge of US$43 billion in civil settlements and penalties in connection with the spill, and the negative fallout in terms of public relations is significant.

Or take the Bangladesh garment factory collapse of 2013, with the loss of 1,129 lives. A number of North American and European retailers ended up in the news, not because they had any ownership stake in the factory but because their suppliers did. In the wake of the tragedy, they suffered a hit to their reputation, with some agreeing to pay compensation to families of the victims. The lesson here is that the public is quickly losing patience with companies that fail to act in a sustainable, responsible way.

“I think the whole concept of shareholders being the only stakeholders that are important is going away, and there’s a growing sense that companies must address these issues,” says Deb Abbey, CEO of RIA.

The good news is that when employees believe their company is paying attention to governance and the environment, they become more motivated, according to Abbey. The communities in which they operate also respond positively, making it more likely for companies to win support for plans and projects. The bottom line, says Abbey, is that ESG has become a route to profits.

So how can investors take advantage of ESG? It’s still a young trend and there are relatively few third-party sources of data on individual companies for the retail investor. Companies such as Sustainalytics and Bloomberg collect extensive information, but their mostly corporate and institutional clients pay big fees to access that information.

Sustainalytics does compile an index of 60 major Canadian companies that have met a set of ESG-rating targets and the list of constituents is publicly available. Retail investors should find it a good starting point.

But perhaps the best resource for individual investors is ESG-focused mutual funds.

In Canada there are about a dozen fund companies offering mutual funds with an ESG component. The main players are NEI Investments; Meritas Mutual Funds, which is a division of OceanRock Investments Inc.; and IA Clarington Investments. Some of the banks are also dipping in their toes, including Royal Bank of Canada and its subsidiary PH&N Investment Services.

AGF, an independent fund company, has been offering a clean energy fund for more than two decades. The AGF Clean Environment Equity Fund invests worldwide in clean technology and resource-based environmental innovation.

NEI, with $6.4 billion under management, aims to build wealth while reflecting the ESG practices of its investors, expressed through a proprietary evaluation methodology.

In terms of choosing between the many alternatives, investors would do well to turn to RIA, which provides useful performance metrics of most of the major ESG funds. Another source of information is, of course, your investment adviser. If you haven’t got one, RIA has a comprehensive list of ESG-accredited advisers on its website. Advisers have the training and access to industry data to provide clients with the help they need.

The ESG universe is a big space and for many investors the biggest challenge will be figuring out which part of it they want to concentrate on. That’s where an adviser should be able to provide the most help.
In the early days, many mutual funds employed a simple, bare-bones approach: don’t invest in companies that do things you don’t like, which typically meant saying no to tobacco companies and arms manufacturers. The industry has evolved dramatically since then.
Companies such as NEI now offer funds targeting a range of sustainability-related issues, from climate change and governance to the rights of indigenous peoples.

“We’ve been working for a number of years to ensure that [mining] companies consider human rights [as part of the process] in order to gain access to the resources they need,” says Bob Walker, vice-president of ESG services at NEI. “That’s just one area.”
NEI is also active around global warming, pushing companies to reduce carbon emissions.

The company does a lot of work with businesses involved in developing the oilsands, especially in the area of tailings pond management and reclamation, Walker says. “We believe it is possible to develop the oilsands in a responsible way. Obviously, it’s a huge challenge for companies in Canada, but we have seen movement in this area.”

In addition, NEI is homing in on the palm-oil industry, which has seen explosive growth as producers level tropical rain forests in order to make way for new palm-oil plantations. NEI is lobbying the industry to adopt sustainable practices as a way to reduce or eliminate the negative environmental fallout. Walker believes NEI’s efforts on that front have already borne fruit.

“This is not about saying no — it’s about engaging for change,” he says.

Meritas is another leader. Relying on both in-house expertise and external advisers, Meritas encourages better corporate behaviour through a range of strategies, from negative screening (in other words, avoiding companies from certain sectors) to shareholder activism. Investors must be willing to put up a minimum of $150,000.

Sucheta Rajagopal, a financial planner and portfolio manager with Jacob Securities Inc. in Toronto, advises beginner ESG investors to start off cautiously. “Start by buying one ESG fund and see how [you] feel about it,” she says. “The best way to do that is to tell your adviser you are interested and ask him or her to come up with a couple of choices.”

Rajagopal is one of a few accredited advisers in Canada providing clients with bespoke services, custom-building ESG portfolios. If an investor wants to focus on a specific issue such as gender diversity or corporate governance, she can arrange that.

With approximately 150 clients and a minimum investing requirement of $150,000, she can go well beyond conventional mutual fund options, in some cases arranging investments in individual companies. For example, she has placed clients in a private recycling company. She can also recommend community investments, such as Solar Share, a Toronto-based solar energy cooperative aimed at creating solar energy projects and hooking them up to the Ontario grid.

Another investment choice is New Flyer, a Winnipeg-based manufacturer of energy-efficient buses that sells to municipalities across North America.

Still another is Tesla Motors Inc., an electric carmaker headed by tech billionaire and entrepreneur Elon Musk. The major auto manufacturers have been struggling to come up with a successful electric car for decades, but California-based Tesla, whose shares have soared in recent years, appears set to beat them at their own game with its novel technology and premium-priced vehicles.
As momentum around responsible investing continues to build, mainstream players are becoming involved. In 2014 CPA Canada, in collaboration with the Toronto Stock Exchange, published A Primer for Environmental & Social Disclosure, outlining the arguments behind corporate disclosure of both voluntary and mandatory ESG metrics.

“Pressures to manage and disclose environmental and social issues material to the business may come from directors or trustees of issuers, senior management and/or employees,” the primer says. “They see positive bottom line benefits — for example, cost savings, increased revenue streams through innovative products, an advantage in attracting, retaining and motivating employees, improved risk management, enhanced reputation and customer loyalty.”

Even Bloomberg has joined the movement. The global data company now provides ESG metrics on more than 10,000 companies in 52 countries. It also provides analysis on clean energy and low carbon technologies and carbon markets.
ESG investing is becoming recognized as just good business, says Lang. “The corporate world is realizing that companies that have strong oversight of environmental and social issues tend to have better governance and better management.”

John Greenwood is a Toronto-based freelance writer.

This article was originally published in the January 2015 issue of CPA Magazine.