The market has gone from famine to feast when it comes to investment opportunities in environmental, social and governance (ESG) programmes and metrics to analyse them. The importance of sustainability for business and investing is intensifying as financial markets are now forced to address challenges posed by, among others, the scarcity of natural resources, negative impacts of carbon emissions and climate change associated risks.
Across all sectors, corporations have moved ahead with corporate social responsibility policies in the last decade, but we observe an inertia in the investment community. In particular, when dealing with ESG evaluation, investors are faced with numerous challenges and complications that require a more sophisticated response than at present in order to make a meaningful impact on the business environment.
The hurdles in navigating the sustainability landscape
Perhaps the greatest challenge facing the investor community, and the centre of heated discussion at the recent Bloomberg Intelligence & EPRA Real Estate Summit 2019, is effectively dealing with the myriad sustainability initiatives in existence. Whether the Sustainable Development Goals (SDGs), the Principles for Responsible Investing (PRIs) or any number of other initiatives, the volume of choice in this area can ultimately lead to a lack of clarity around what is financially relevant and what is not.
A range of ESG criteria and factors provides corporations and investors with options from which they can pick and choose their ESG priorities, which is good. The other side of the coin presents a varied landscape of confusing specifications that are not always easy to understand or qualify.
This applies to both corporations proving their ESG credentials to investors and to investors and asset managers proving their own ESG selection criteria to end investors. Among the latter, many assert that sustainability dynamics somehow have no impact on financial assets. Others say they are doing environmental and social good. But how deep is an investor’s understanding of how a business or a fund truly aligns with global commitments?
To cut through the confusion, box-ticking measures, which ease the process of communicating ESG measures, are not uncommon. And while many corporations and investors undertake these with good intentions, it opens the door to the phenomenon of greenwashing, which can be as damaging to investor returns as it is to social and environmental outcomes.
Profitability as important to sustainable business as ESG
But the matter does not begin and end with social and environmental good. At the moment, profitability and sustainability are too often treated in parallel coexistence; yet integrating the two is paramount to successful ESG business practices. Long-term profitability and environmentally and socially positive business should increasingly be seen as the same.
However, the tendency to give too great a focus to short-term measures, like quarterly reporting, is widespread. Among listed businesses, in particular, this represents a major obstacle for companies embedding sustainability in their strategic planning and capital investment decisions. In reality, it is hard to see how a business, under investor pressure for short-term earnings, can effectively implement projects with an ROI horizon of five years or more when a business’ principal focus is on quarterly financial reporting.
Right now, analysts understand how to read a company balance sheet, assess forecast projections and ascribe a business or fund a financial value. A new breed of analyst is required for a changing business environment. As with any other issue related to the prudent management of capital, investors have a fiduciary duty to include sustainability consideration in their decisions. What is lacking is the training required to ascribe businesses a long-term, sustainable profitability valuation based on metrics that apportion equal value to how a business is run socially and environmentally and how that business is run financially.
But first, all businesses must disclose financially material ESG data. In real estate, where my expertise lies, we are starting to see change like this happen. Five out of every six EPRA listed real estate members have signed up to our Sustainability Best Practices Recommendations, which set the industry standard for ESG data disclosure. There is still work to do, but the appetite for ESG reporting is high, and EPRA’s ESG workshops, which provide training in this field, are consistently oversubscribed.
Listed businesses leading the way
Our members do benefit from their status as publicly listed, which brings with it high expectations for ESG data disclosures and transparency, and, in theory, their investors should benefit too. However, the listed real estate industry, like many other industries, is doing its part in ESG reporting. The onus is now on investors and analysts to cultivate a self-improving ecosystem by increasing the sophistication with which they understand and use ESG data.
This last point is mired in challenges. For example, a fund manager marketing a socially responsible real estate fund needs to work out the extent to which they want their portfolio to do real social good versus just achieving a green evaluation on their product. There is a big difference between funding something that is in the process of doing something good – for example, a business that invests in derelict, out of town property and makes it into something that benefits society – and buying a Central London office block with a sustainability certificate that provides the fund’s rating with an A-grade ESG score. Each option is sustainable but might well produce different impacts. How do you communicate this difference effectively to investors?
Ultimately, businesses, particularly those that are listed, are making positive steps towards tangible and meaningful sustainability. The investment community must put pressure on itself to do the same and increase the sophistication with which they assess the ESG factors in their portfolios and the way they market this. But at the end of the day, improving training and understanding around ESG data disclosure and analysis is the key to a sustainable business future, and we are only at the beginning of that journey.
This article first appeared at BusinessGreen.com