Corporates are feeling the heat as governments and investors demand they take greater responsibility for their environmental and social impacts. Until now, a comparable approach to measuring these risks across companies, investment funds and indices has remained a challenge.

Traditionally, large companies have been relatively free to pursue growth and maximise profits, without too much concern for the costs that growth creates elsewhere in society. However, the challenges of unencumbered growth have reached levels that are untenable in many cases. As a result, regulations are tightening and social pressure is forcing companies to recognise their wider impacts in areas like climate change or social inequality. Change is inevitable and gathering pace.

Andrew Howard, Schroders’ head of sustainable research, explained: “Companies now face the dual challenges of meeting tightening regulations, such as gambling restrictions, minimum wage legislation, sugar taxes and carbon pricing – and investors demanding both returns and better outcomes for society.

This demand for corporations to take greater responsibility for their ESG (environmental, social and governance) impacts, is becoming a growing financial challenge rather than a theoretical question. Industry growth, costs and leadership will be reshaped as those pressures play out.  Investors cannot afford to ignore the challenges and risks companies face.”

ONE THIRD OF LISTED COMPANIES TO BECOME LOSS MAKERS

Andrew Howard, head of
sustainable research

Research by Schroders discovered the significant impact these risks can have on future returns and investments. It shows that if all social and environmental impacts were taken into account as financial costs, the $4.1 trillion earnings that listed companies generate for shareholders, could tumble by 55% – falling to $1.9 trillion.

“Viewed in this light, one third of those listed companies would become loss makers,” Howard said.

Being able to quantify these risks means investors and companies are better informed and can make decisions accordingly. But with no standard across-the-board global measurement, how do investors find these very real costs hidden deep within a company’s social and environmental impact disclosures?

Howard comments that forward-looking active investment involves understanding how a company interacts with society and its environment.

He believes it also means needing to accurately analyse profit lines and risk exposure.

“Companies don’t operate in a vacuum – they affect society and are affected by society. We’ve developed a new tool and framework – SustainEx – to quantify those impacts in economic terms. It asks the question – if companies were given a bill for the costs they impose or the benefits they create, how large would that credit or debit be?”

MEASURING THE REAL COST ACROSS THE BOARD

The SustainEx model was developed using data gathered from more than 9,000 large global companies.

In order to provide greater insights, researchers also investigated unconventional data sources. These included assessing a range of disparate information, from patent registrations, to work stress perceptions, innovation, wage discrimination and even smoking.

Their analysts also assessed 47 individual social and environmental impacts pertaining to each individual company, and scrutinised more than 400 academic and industry studies, which they combined with company level data to examine companies’ exposures.

To ensure comparability between companies, Schroders selected measures that were quantifiable, so that costs and benefits were measured and compared objectively, were attributable, and were disclosed widely, so that comparisons between global companies were possible and transparent.
 
Howard said: “Alongside other researches and methodologies we have in place, this new tool adds to our ability to measure the costs companies could face if their negative externalities were priced, helping analysts identify companies that face the greatest risks and the sources of those risks, as well as their peers with positive impacts who should be more protected.
 
This analysis provides fund managers and clients with a systematic, quantitative measure of sustainability risk that can be applied across investment strategies, where previously some areas identified would not be easily captured using commonly available data.”
 
By quantifying social and environmental impacts in economic terms, SustainEx provides an approach that can be measured across companies, funds and even indices. Investors with specific priorities can also use this tool to assess impacts in terms of ESG.
 
According to Howard, the asset manager sees SustainEx as an effective and practical measure of corporate sustainability that is now integrated into its systemic investment strategies. It can also be considered as a standalone measure to use in specific investment strategies.
 
“Going forward, we expect costs to continue rising, reflecting the expanding role of listed companies in the global economy and society, making analysis of these impacts increasingly important. Social and environmental change is happening faster than ever – climate change, shifting demographics and the tech revolution are reshaping our world. Companies that can adapt and thrive will be more successful in attracting customers, employees and growing their business,” Howard said.
 
Schroders is rated A+ for their approach to sustainability by the United Nation’s PRI organisation and the No.1 asset manager by ShareAction[1].
 
Please click here to view a 90-second video on SustainEx and more about Schroders’ approach to integrating sustainability considerations across investment processes to achieve long-term return.

[1] 2017 Share Action Responsible Investment Survey of European Asset Managers; A+ rating: Principles for Responsible Investment 2015, 2016, 2017 and 2018 assessment reports