In one of our surveys from the beginning of the year, a high proportion of our users indicated that they place particular value on corporate sustainability and miss transparency in this regard. Almost as many respondents were willing to forgo part of their returns to support companies that act sustainably. That's nice to hear - however, sustainability and returns are not contradictory!
What are ESG criteria and why do they play a role in stock investments?
ESG criteria (environment, social and governance) concern the environment, society and the management of a company and go beyond financial metrics. A clear trend can now be observed among institutional investors: in a 2019 study, 70 senior executives at 43 international investment firms indicated that they now have a strong awareness of ESG investment criteria (including BlackRock, Vanguard, and State Street).
These developments have various reasons. This includes first of all an updated understanding of fiduciary duty: while a few years ago sustainability was still considered negligible, more recent legal opinions and guidelines now make it clear that it constitutes a breach of fiduciary duty not to consider such factors. And this is not only due to increasing demand among many private investors - especially younger generations are often concerned with more than absolute profit maximization. In fact, many institutional investors are now convinced that neglecting sustainability aspects can damage returns in the long term.
The reasons for the risk are obvious. For companies like Shell, the finite nature of oil reserves also means the finite nature of a viable business model and thus of revenues - unless a sustainable approach is found (environment). In cases like Wirecard, scandals in the company's management caused the stock to collapse completely within a few days (governance). Even in less severe cases, companies often face fines and negative ratings that can depress the value of a stock for a long time.
"Traditional financial metrics such as earnings, debt and profitability do not come close to ESG metrics as signals of future earnings risk or earnings volatility."
- Savita Subramanian, Head of US Equity & Quantitative Strategy, Bank of America
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What challenges currently exist for sustainability-oriented investors?
Not only for a clear conscience, but also for sustainably profitable and stable investments, it makes sense to take a look at a company's sustainability. However, this is not so easy. The greatest difficulties currently standing in the way of sustainable investment decisions are a lack of transparency as well as uniform factors in reporting and analysis. And while a large part of the responsibility lies with governments and the companies themselves, many large analysis institutes and fund managers are also striving to meet the growing demand for transparency and accountability.
How we at Leeway contribute to more transparency and accountability.
At Leeway, we want to actively contribute to this movement and will now introduce our clear ESG score. For this purpose, company websites, publications as well as annual reports and sustainability reports (for now) are searched for a good two dozen essential ESG criteria.
In principle, we collect both quantitative data and information about certifications, implementations and methods of companies. Quantitative data (i.e. emissions, waste, pollutants, taxes and investments for the benefit of the earth and community) are in most cases put into relation to the economic performance of the company and evaluated. This is because rapidly growing companies understandably record increasing pollution rates. In some cases (such as the quota of women in management), economic performance is irrelevant.
Qualitative data, measured for example by ISO standards up to whistleblower hotlines, reflect how much effort a company makes to establish and fulfill guidelines for ethical conduct.
The non-publication of this data is generally rated negatively by us. We are currently working on refining our scores as well as a data portal in which ESG data can be directly entered and corrected.
