The Oracle of Omaha once said, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”
These all-too-familiar words of wisdom by Warren Buffett carry even greater weight today, as more asset owners demand the inclusion of ESG (Environmental, Social & Governance) considerations into the asset selection and review process.
But why this sudden emphasis?
How the Past Guides the Future
If history is any guide, the aftermath of stewardship failings often results in reputational damage, financial losses, a collapse in share price, or outright bankruptcy.
Enron’s demise in the early 00s and Lehman Brothers’ meltdown at the height of the global financial crisis offer stark reminders of how companies that engage in shady practices can see their fortunes turn at the blink of an eye.
No longer is the pursuit of short-sighted profits enough for shareholders, nor is returning these earnings as outsized dividends enough to satisfy their investment mandates. And, no longer is the price of a company’s stock regarded as the sole gauge of over- or under-performance.
“To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society,” argues Larry Fink, leader of the world’s largest asset manager, Blackrock, Inc., in his 2018 open letter to CEOs.
“Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”
ESG Investments Pick Up Steam
So, do the metrics match the prevailing sentiment of the time? By one count, the Global Sustainable Investment Alliance reports that ESG-integrated assets under management grew 38 percent between 2014 and 2016.
Independent Insight Provider Lightbulb Capital, which publishes on Smartkarma, believes this stellar growth is “largely fuelled by asset owners and regulators.”
At a time when ESG integration demands from asset owners are growing, those that have a framework in place will be well-positioned, says the research firm.
Beware of Flawed Benchmark Assessments
Many companies have already begun rethinking their business goals and reorganising their long-term strategies in response to this new, ESG-conscious reality. The onus now falls on investment managers to determine whether these efforts adequately meet the stringent standards required to be considered ESG-worthy.
The reviewing process can sometimes be cumbersome, if done from scratch. Hence, it’s only natural that some asset managers turn to so-called trustworthy benchmarks to serve, at least, as an initial filter.
Therein lies the danger.
Take, for example, the cap-weighted MSCI India ESG Leaders Index. Of the Index’s top 10 constituents, three of four from the financial services sector made headlines in 2018 for alleged regulatory infractions, from financial misreporting to nepotism. For example, read how a Smartkarma Insight Provider called out Yes Bank more than a year before India’s central bank did.
A year prior, two of the top Index-listed companies from the IT sector took a hit: Infosys Ltd. was embroiled in a severance-package and acquisition scandal that ultimately led to its CEO’s resignation, while Tata Consultancy Services Ltd. was slapped with a nine-figure fine by the US for stealing trade secrets.
ESG Index Spoilers
Scandals surrounding half of the top 10 companies call the MSCI India ESG Leaders Index into question.
Rank | Company | Index Weight | Sector |
1 | HOUSING DEV FINANCE CORP | 16.08% | Financials |
2 | INFOSYS | 13.23% | Information Technology |
3 | TATA CONSULTANCY SERVICES | 10.03% | Information Technology |
4 | AXIS BANK | 6.12% | Financials |
5 | HINDUSTAN UNILEVER | 6.07% | Consumer Staples |
6 | ICICI BANK | 4.28% | Financials |
7 | MAHINDRA & MAHINDRA | 3.78% | Consumer Discretionary |
8 | YES BANK | 3.07% | Financials |
9 | HCL TECHNOLOGIES | 3.06% | Information Technology |
10 | BHARTI AIRTEL | 2.82% | Telecommunication Services |
Source: MSCI India ESG Leaders Index
The Index claims to provide “exposure to companies with high Environmental, Social, and Governance performance relative to their sector peers.” Such incidents call into question the benchmark’s credibility and reliability. They also raise the question whether investment decision-makers should place blind faith in other ESG-based indices.
“ESG and the broader Sustainability Analysis cannot be outsourced to a benchmark. Sustainability and ESG analysis are medium-term subjective calls, while benchmarks require short-term regular objective inputs,” says Munib Madni, CEO of Panarchy Partners, a firm that plans to redefine sustainable investing.
“Real active management is entering a new era, where financial returns will need to be viewed in conjunction with returns on human, social and environmental capital. These cannot be captured in benchmarks.”
Bottom line: ESG benchmarking still has much to fix.
The Need for More Proactive Engagement
The need for increased direct engagement is all the more important because of ESG non-disclosure or only partial disclosure.
Not only does asking thoughtful questions help investors better understand the data companies provide, two-way engagement also creates the rare opportunity for investors to share with companies how ESG is integrated into their investment analysis, Lightbulb Capital explains.
Frequency of engagement is important too – it establishes greater company familiarity and better equips asset managers to make more accurate asset assessments.
“If engagement is to be meaningful and productive – if we collectively are going to focus on benefitting shareholders instead of wasting time and money in proxy fights – then engagement needs to be a year-round conversation about improving long-term value,” says Fink.
