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ESG – extremely strong gains

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Globally, sustainable investment now exceeds 30 trillion dollars. That’s up almost 70 percent since just 2014 and up 10x since 2004.

For sure, this enormous rise can be attributed to better awareness and consequent commitment on the part companies and investors. Companies have come to appreciate how socially responsible investing can protect their long-term futures through sustainability. Investors have seen these investments gain traction and allocated a part of their portfolio to them. And society too has collectively decided that it’s tired of the old “exploit to the max and then discard” model and has demanded a paradigm shift toward the “people, planet and profit” model.

But don’t think for a minute that these huge asset allocations to ESG (environmental, social and governance) investments is driven solely by some sort of macro-level conscience shift, with megafunds piling cash into them in order to salve their conscience, or that the investment community is buying into these funds purely on the basis of some kind of karmic compensation. The reality is quite the opposite. So much so that we could reasonably start interpreting ESG as extremely strong gains.

A recent McKinsey report has exhaustively digested more than 2,000 studies of the impact that ESG propositions have on overall equity returns and has found that 63 percent of the studies concluded with positive findings.

Many healthy, stable and profitable firms with poor cash flow management can struggle to survive an unforeseen dry spell with no cash coming in, as we have witnessed through the forced lockdown and consequent shuttering of businesses around the world as a result of the COVID-19 pandemic. McKinsey’s yearslong research on the subject reveals that ESG drives cash flow in five significant ways.

Driving top-line growth

ESG-focused companies stand in good stead with both consumers and governments. On the consumer side that means it’s easier for them to consolidate market share, ward off competitive advances and launch new products. Their good social standing also favors more rapid approval from governments in terms of regulatory approval and licenses, making it easier for them to expand into new territories, thereby expanding their global footprint and further diversifying their revenue streams.

Reducing costs

Effectively harnessing the “E” (environmental) in ESG can reduce a company’s operating costs, with the savings going straight to the bottom line. Clearly, newcomers to the ESG party are likely going to have to swallow some significant one-off adaptation and business process reengineering costs, but the longtime converts are already seeing the benefits. As McKinsey notes, FedEx is making a determined push to have its entire vehicle fleet running on electric or hybrid engines, and the 20 percent that have already been reconfigured are delivering savings of 190 million liters annually.

More nimble legal and regulatory approvals

Strong and meaningful ESG engagement enhances a company’s public image, and this can help cleanly grease the administrative wheels when entering new markets or applying for operating licenses in sensitive or highly-regulated sectors. And governments looking for allies in public-private partnerships are logically going to get into bed with organizations of good social standing ahead of their less transparent and committed competitors. Supervision and/or intervention by governments in critical industries is less likely to impact on companies that proactively focus on the “G” (governance) in ESG, which can ultimately cost millions in terms of legal appeals, rejected takeover approvals and corporate reputation.

Engaged workforces

People want to feel good about the companies they work for. Organizations that deliver on the “S” (social) in ESG enjoy higher productivity, and higher productivity translates directly into higher earnings. Not to mention talent retention and acquisition, which is critically important to those companies seeking in-demand profiles to spearhead their digital transformation strategies. Conversely, organizations that leave the social dimension aside in the ruthless pursuit of profit will trip themselves somewhere along the way: weak labor relations will lead to more strikes, poor supervision of outsourcing collaborators can disrupt supply chains and consumer sentiment can wane quickly in an economic slowdown.

Better investment frameworks

A solid ESG proposition can boost a company’s investment return by directing capital to promising opportunities that can offer outsize yields as a result of getting in on the ground floor. Refreshing investment capital allocation can also help prevent expensive writedowns on historic investments that have reached the end of their useful life. Better to adapt and spend now than run the risk of having to play catch-up later down the line.

If the ESG story of extremely strong gains sounds either too good to be true or too “save-the-planet”, then just take a look at the rainmakers of the global investment world and how seriously they are taking it. McKinsey recalls that “shocking” letter from Blackrock’s Larry Fink last year, in which he laid out the new rules of the game for CEOs, telling them in no uncertain terms that dramatic capital allocation changes were coming down the line on the back of fund managers’ responding to the impact of climate change. As Fink declared, “a company cannot achieve long-term profits without embracing purpose and considering the needs of a broad range of stakeholders.”