Investors Still Don't Get Accountability

A recent survey shows many don't understand that a company's high score on social responsibility indices also signals good risk management

by Alyson Warhurst

Nearly 70% of fund managers still do not regard it as standard practice to factor environmental, social, and corporate governance initiatives into their investment decisions. That was the headline finding of a recent survey of 40 institutional investors undertaken by the advisory firm Maplecroft, of which I am a director, on behalf of logistics and transportation company TNT (TNT.AS) and the World Economic Forum.

Not surprisingly, what investors do factor into their decisions is proficiency in risk management. They prefer buying into companies that have clearly identified problems potentially affecting future performance—everything from the impact of carbon emission regulations to whether HIV/AIDS rates in some countries could limit the availability of staff. Investors look even more favorably at companies that have developed strategies to mitigate the identified risks.

But the fact that investors value good risk assessment more than corporate programs aimed at addressing environmental, social, and governance (known as "ESG") issues is a curious disconnect, because in many respects they're two sides of the same coin. After all, ESG issues can have serious cost implications for business—and thus need to be considered in any risk-management context.

How to Find ESG-Sensitive Equities

The conclusion from our study was twofold. First, to the extent fund managers don't pay as much attention to ESG as they do to risk management, they are losing the ability to perceive long-term challenges facing their investments. And second, companies that are leaders in sustainability—broadly defined as paying close attention to the environmental, social, and human impacts of their activities—aren't always succeeding at communicating to investors the depth of their risk assessment and the management procedures they have in place.

There is an easy shortcut to better understanding. Socially responsible investors already employ specific ESG screens for picking stocks. But there are also a variety of sustainability benchmarks and indices available to mainstream investors, such as the Dow Jones Sustainability Index (DJSI), the FTSE4Good, and the Business in the Community (BITC) Index, that do a rigorous job of screening companies for inclusion based on criteria such as corporate governance, risk and crisis management, eco-efficiency, environmental reporting, and labor practices. Only companies with the most robust non-financial management systems can achieve these high standards, so inclusion in the indices is an excellent proxy for sustainability.

What the majority of investors don't seem to appreciate is that being included in sustainability indices like the DJSI also speaks volumes about a company's risk management proficiency. Indeed, one would think high scorers should be regarded as "must-have" investments for that reason alone. Instead, mainstream investors aren't grasping the fact that high performance on sustainability indices usually implies a company is better than most at assessing and managing all kinds of risk.

A Reporting Gap

Some of the blame falls back on companies. Many rely on their annual corporate responsibility reports to showcase initiatives designed to address environmental or social risks. Yet none of the fund managers interviewed by Maplecroft said they read these. This creates a reporting gap that companies need to address if they want their long term risk management proficiency to be recognized by shareholders. In particular, they should explain the business case for ESG initiatives in the language of risk and risk management—not just as a social good—and report on these risks alongside financial figures as part of their annual reporting process. Few companies are doing this now, though TNT says it will start this year.