In 1970 the Nobel-prize economist Milton wrote in the New York Times that the only social responsibility of a company is to increase profits in accordance with moral rules. This view was not surprising at the time, it just validated the status quo. Nonetheless, this article triggered a debate on company social responsibility that today is still a hot topic.
Nowadays, the role of change-leading companies in driving social responsibility is clear to everybody. What’s more firms and financial institutions are demanded to comply with compelling environmental targets at worldwide level.
The ESG spending up has been driven by accelerated social, governmental, and customer focus on the broader impact of corporations: investors and executives soon realized that a strong ESG proposition can secure companys’ long-term success. And the great amount of investment flows in ESG can only suggest that it is much more than a good practice. Indeed, customers are willing to pay the cost of going green: ‘’upward of 70 percent of consumers surveyed on purchases in several industries, affirmed that they would be ready to pay an additional 5 percent for a green product if it met the same performance standards as a non-green alternative’’- as sustained by a McKinsey’ study. So, asset managers are increasingly recognizing the importance of integrating social and environmental factors in their value chain and operating models.
However, implementing the ESG framework is a daunting process that ideally consists of : developing an ESG strategy (e.g. benchmark analysis with direct competitors or product offering strategy)-implementing an ESG investment process- developing and reviewing environmental policies- investing in new technologies- build an environmental-oriented skillset and mindset within the workforce- monitoring and disclosing the final performance (e.g. defining KPIs and linking them to sustainable development goals.)
But the point is: do financial returns offset the huge costs required to incorporate ESG into the company’s structure?
It is largely recognized that the right ESG strategy can provide a positive impact on long‐term investment performance. The key success factor in ESG investing is the full integration of ESG components into the company value chain. Yet, most investment managers fall well short of full integration, resulting in firms’ performance that is normally- distributed, with many firms performing somewhere around the mean, and only a few distinguished showing an interesting ROI.
Within ESG integration, managers employ a variety of ESG methods, spanning from active ownership/engagement to positive screening (selecting certain attributes), relative weighting, to risk analysis. Full ESG integration means showing an authentic commitment to the incorporation of ESG risks and opportunities in the investment analysis.
However, the reasons why many asset managers show flat returns is that ESG factors are because ESG implementing follows a J‐curve trajectory in which most of the costs are up-front, and rewards are not immediately cashed, if not at all. In addition, there are several obstacles to full integration, mostly attributable to the lack of ESG performance standards.
Even more concerning is the mismatch between ESG’s long‐term benefits and firms’ short‐term performance incentives. In fact, companies which decide not to incorporate ESG in their investment analysis benefit from a way larger portfolio and risk diversification due to less stringent screenings with respect to their ESG competitors. This is a clear disincentive for ESG implementation.
Nonetheless, there are also many opportunities for growth: a strong ESG proposition enables companies and financial institutions to tap new markets and expand into existing ones, building a trustful relationship with governing authorities, who are more eager to award them access, approvals, and licenses. Also, ESG permits to downsize company cost-structure by way of reducing operating expenses (e.g. raw-material, water, or carbon), establishing a positive correlation between performance and energy-saving. Another upside of ESG is that it instills a sense of higher purpose in employees, directly impacting performance and economic rewards. Finally, ESG creates higher-valued financial assets by investing capital in promising opportunities.
Overall, ESG factors represent a huge growth opportunity, but also a non-neglectable risk. Then it is of paramount importance to consider all the expected costs and the initial expected loss before its implementation, But for sure it is a cannot-miss opportunity for many businesses. And It is up to any company to implement it in the most rightful way.