The Long-term Growth of Sustainable Investing

In April 2013, the concrete roof of a dilapidated factory in a densely populated district of Dhaka, Bangladesh, housing thousands of mainly female garment workers, caved in. A total of 1,134 people were killed and more than 2,500 injured.

The tragedy illustrated the human cost of some aspects of globalisation which had, only a few years earlier, prompted the United Nations to institute its Environmental, Social and Governance (ESG) principles — and the disaster highlighted the urgent need for global business to take the aims seriously. The fact that many of the dead workers had been producing items of clothing for international fashion brands, including Benetton, Primark, Walmart, Prada and Gucci, turned a Third World calamity into a global embarrassment.

The rapid growth of Bangladeshi “sweat-shops” over the previous decade in response to Western needs, had led to overcrowded factories and poor working conditions, coupled with badly maintained buildings. The average wage for garment workers at the time was around $30 a month. In the wake of the tragedy Pope Francis denounced the system as promoting “slave labour”. The shocking incident had another consequence — consumers in the West were suddenly able to contrast the glitzy stores where they purchased their fashionable clothes with the grim reality of the garments’ origins. More importantly, investors who were already questioning the ethical practices of a wide range of business and industry sectors, reacted negatively to the stark images of death and destruction in Bangladesh.

Dr James Gifford, who had been a “shareholder activist” in his native Australia years before, and was among the group of “free thinkers” who had shaped ESG strategies in the early 2000s, was the executive director of the UN’s Principles of Responsible Investment at the time of the Dhaka factory incident. He said, “It is absolutely in the financial interests of leading Western clothing brands to have safe factories and not to have scandals. We’re now seeing all the clothing brands scrambling to sign up to new protocols on building safety. This is the change that the world is seeing. Formerly people thought there must be a trade-off between profits and looking after workers or looking after the environment. Companies need to look after the issues that are going on in their supply chains.”

Transparent supply chains are just one of the issues global business is tackling. Investor and consumer knowledge, together with the power of social media, has put every industry under the ESG spotlight. Indeed, ESG aims are now part of the mainstream of business in Europe and the US. Even the disruption caused to global trade by Covid-19 failed to interrupt the continued adoption of ESG codes. Amy S. Matsuo, Regulatory and ESG Insights Leader at KMPG US, says that the global pandemic, far from provoking an investor flight back from sustainable investing to traditional, has amplified ESG awareness — and not only with investors, but with policy-makers and consumers. She says: “Pressure from investors, employees, customers and the general public has driven companies to commit to and act upon an ESG strategy, focusing primarily on environmental factors. With the advent of Covid-19, stakeholders are turning attention to workplace safety, employee health and well-being, job security, data privacy, customer engagement, supply chain management, community investment, corporate leadership and innovation. ESG has expanded into a “Main Street” issue with significant reputation risk for companies.”

Dr Gifford, who is now head of Impact Advisory and Thought Leadership at Credit Suisse, says, “There’s a recognition that the world is changing faster than ever. Many of the most important changes are within the ESG bucket. Change is opportunity, and ESG issues, being some of the largest, most important megatrends happening in society, simply translate into opportunities for the cutting-edge of investors to outperform their peers.”

The pandemic, followed by Russia’s invasion of Ukraine in February 2022, have undoubtedly rattled investors. Historically, in times of crisis, investors have tended to play safe, seeking out reliable havens for their money — usually gold or long-dated government bonds. But despite some unease, companies with strong ESG polices have generally outperformed less environmentally-minded businesses. A 2020 study of sustainable investments showed that 60 percent achieved positive returns while only eight percent were negative.

The growth of ESG adoption across the business world since the term was coined by the UN in 2004, shows no sign of wilting in the face of harsh economic times. Companies which demonstrate a belief in sustainability and the ethical treatment of workers are judged to be more trustworthy in an increasingly uncertain environment. According to research by Morgan Stanley’s Institute for Sustainable Investing, sustainable funds offer reduced risk, whatever the asset type, compared with traditional funds. Their analysis suggests that non-ESG funds have a greater downside deviation in volatile markets.

Dr Gifford says ESG analysis and involvement by investors is growing in sophistication. It is no longer just about “picking out the bad guys” from an investment portfolio, or simply investing in obviously green companies like wind farms or solar power, but in actively seeking out companies with potential to make the world a better place. He says: “Investors want to focus on what the boards of major corporations are actually doing, what they’re thinking about, what’s keeping them up at night. With this radical transparency, with social media, with the accountability that corporations are feeling, all of these issues are becoming core to business and core to those investing.”

The war in Ukraine, however, has raised questions over the perceived rigidity of ESG principles — particularly in regard to investment in the defence industry. Arms manufacturers have suffered from a degree of investor flight in recent decades, the sector being seen by many as running counter to ESG aims. In March 2022, a Bank of America report said, in reference to investment in defence industries, that the Ukraine crisis “reminds us that, like most things in investing, ESG is complicated and nuanced”.

The conflict in Ukraine has led some to question whether investing in a strong defence industry should now be considered to be fundamentally “social” in relation to deterring aggressive regimes. An opinion piece in the Financial Times in March 2022 questioned the “blanket approach” of ESG aims, as the effects of war on Europe’s doorstep illustrated the crucial nature of defence. The newspaper argued: “Surely an important component of (Europe’s) ability to provide safety and security to its citizens should qualify for some recognition in the social element of ESG?”

Similarly, in response to the increasing cost of energy, especially in a Europe so dependent on Russian oil and gas, there have been calls to soften climate change priorities. But Adam O. Emmerich, a partner at Wachtell, Lipton, Rosen & Katz, a US law firm, says: “While sustainable investing is fundamentally about generating long-term financial value, the Ukraine conflict has prompted unprecedented support for the liberal international order. The war provides important lessons and underscores the need for a non-disruptive transition to a low carbon world – a view already shared by major investors.

“If unaddressed climate change will trigger a humanitarian crisis on an unprecedented scale and lead to trillions of dollars in losses. From an ESG perspective, a company’s performance is still being measured in returns delivered over decades and not days. Immediate actions necessary to mitigate losses from catastrophic events like the war in Ukraine and the pandemic should be distinguished from the steps that are necessary to preserve a company’s long-term value.”