Institutional investors have been paying attention to environmental, social and governance risk factors long before it was “ESG.” Without fanfare or agenda, these long-term investors took notice of weak governance practices that led to corruption, friction with workforces that led to strikes and factories that spewed toxins into rivers leading to lawsuits from those who lived downstream.
These investors either underweighted short-sighted companies knowing they were destined to underperform their competitors or successfully engaged them to unlock immense value and maximize returns for shareholders and beneficiaries.
Over – what is now – decades, the use of ESG information has changed. This is not because long-standing legal duties have been changed, but rather that what was once detached and disparate information points have evolved into broadly accessible, refined data sets available for all investors. This rise of ‘Big Data,’ combined with advancements in computing power, statistical analysis and now Artificial Intelligence, has transformed financial markets. Rigorous empirical studies, impossible or not cost-effective before, have become ubiquitous.
The new analyses flowing from this revolution will continue to identify long-hidden risks and dramatic opportunities for growth.
Investors also will continue to demand such data because a company’s market value is increasingly based on intangible assets. As the economy has become more digitized, many companies today are valued not by their physical assets, but by intellectual property such as patents, software and copyrights.
Changes in marketing and consumer preferences also mean other intangible – yet critical – assets like brand loyalty, reputational capital and commitments to sustainability and fair labor are now intrinsic to value and return. While these factors may be more difficult to quantify, they nevertheless have a significant impact on a company's valuation and long-term success.
And, for fiduciaries? It’s simply not an option to ignore these increasingly important indicators of value, newly found risks and emerging opportunities.
All this means companies can’t ignore ESG data either.
With growing confidence, investors know that companies that fail to manage ESG risks may face a range of challenges that can lead to poor financial performance and even bankruptcy. For example, companies with poor environmental practices can face regulatory fines, damage to their reputation, or increased operating costs due to environmental cleanup. Companies with weak governance structures may be more vulnerable to fraud, corruption or other misconduct that can harm the company's reputation and lead to legal and financial penalties. And, companies with poor social practices may struggle to attract and retain talent, leading to increased turnover and reduced productivity.
By analyzing ESG data, investors can identify companies that may be more vulnerable to these and other risks and adjust their investment decisions accordingly. By avoiding investments in companies with high ESG risk, investors can reduce the risk of investing in companies that may underperform and increase the likelihood of achieving their long-term investment goals.
In other words, the use of ESG data is simply a routine tool to assess value, potential returns and manage investment risk.
Uriah King
Public Policy & Government Affairs Director, For The Long Term
Dave Wallack
Executive Director, For The Long Term